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Chapter 14: Investing in Stocks

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1 Chapter 14: Investing in Stocks

2 Objectives Describe stocks and how they are used by corporations and investors. Define everyday terms in the language of stock investing. Classify stock according to their basic descriptive categories.

3 Stocks and Bonds and How They are Used
Common stock Voting rights Proxy Vote Preferred stock Cumulative Convertible

4 Investing in Stocks Why do corporations issue common stock?
To raise money to start or expand a business To help pay for ongoing business expenses They don’t have to repay the money Dividends are not mandatory Stockholders have voting rights

5 Why Do Investors Purchase Stock?
Income from dividends Record Date Ex-dividends Dollar appreciation of stock value Increased value from stock splits

6 Return on Investment Assumptions:
100 shares of common stock purchased April 18, 2014, sole April 18, 2015; total dividends of $2.21 per share for the investment period. Cost when Purchased Return when Sold 100 $42.75 = $4,275 100 $56.25 = $5,625 Plus commission Minus commission Total investment $4,304 Total return $5,591 Transaction Summary Total return $5,591 Minus total investment - 4,304 Profit from stock sale $1,287 Plus dividends Total return for the transaction $1,508

7 Common vs. Preferred Stock
Common stock get dividends depending on profit the company makes Preferred stock receive cash dividends before common stock holders pre-determined dividend rate most preferred stock is callable

8 Features of Preferred Stock
Cumulative preferred stock unpaid cash dividends accumulate and are paid before cash dividends to common stock holders Participation feature rare form of investment can share in earnings beyond stated dividend amount Conversion feature can be traded for shares of common stock

9 Classifications of Common Stock
Income stocks Growth stocks Cyclical stocks Defensive stocks Large cap stocks Capital > $5 billion Mid cap stocks Capital between $1 billion and $5 billion Small cap stocks Penny stocks

10 Types of Stock Investments
Blue chip stock low risk consistent dividends ex. AT&T, Kellogg's, General Electric Income stock higher than average dividends ex. utility stock

11 Types of Stock Investments
(continued) Growth stock - earns above average profits low or no dividends Profits reinvested in company, so... Stock price should go up ex. Microsoft or Intel

12 Types of Stock Investments
(continued) Cyclical stock follows business cycles of advance and declines in the economy ex. new construction, cars, timber Defensive stock remains stable even if the economy is declining ex. food and utility stocks

13 Stock Advisory Services
A good supplement to information in newspapers Charge a fee Hundreds to choose from Standard and Poor’s reports Value Line Moody’s Handbook of Common Stock On-line services allow access to web sites such as and

14 Numeric Measures to Consider When Evaluating a Stock
Look at book value of one share net worth of company divided by the number of outstanding shares if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development

15 Numeric Measures to Consider When Evaluating a Stock
(continued) Look at the price earnings ratio also called the P-E price of one share of stock divided by the earnings per share of stock over the last 12 months a low number means could be a good time to buy it, however many technology stocks have high P-Es Look at the beta for the stock stock with a beta >1.0 means more volatility

16 Earnings Per Share Earnings Per Share are a corporation’s after-tax income divided by the number of outstanding shares: Assume XYZ Corporation has after-tax earnings of $2,500,000. Also assume that XYZ has 1,000,000 shares of common stock. This means their Earnings per share would be $2.50: After-tax income Earnings per share = Number of shares outstanding $2,500,000 1,000,000 = $2.50

17 Price-Earnings Ratio The price of a share of stock divided by the corporation’s earnings per share of stock. Using the example in the last slide, the Earnings Per Share were $2.50. Assume that XYZ’s stock is selling for $50 per share. Their P/E Ratio would be 20: Price per share Price-earnings (P/E) ratio = Earnings per share $50.00 = $ = 20

18 Dividend Payout Dividend payout is the percentage of a firm’s earnings paid to stockholders in cash. Assume Ford Motor Company paid out an annual dividend of $0.40 per share. Also assume Ford Motor Company earned $1.44 share. The Dividend Payout would be 28%: Dividend amount Dividend payout = Earnings per share $0.40 = $ = 0.28 = 28%

19 Current Yield Current yield is the yearly dollar amount of income generated by an investment divided by the investment’s current market value. Assume Ford is currently selling for $10 per share. The current dividend yield is 4%: Annual income amount Current yield = Market value $0.40 Current yield = $ = 0.04 or 4%

20 Buying and Selling Stocks
Primary Market Initial Public Offering (IPO) Secondary Market Security Exchange New York Stock Exchange (NYSE) American Stock Exchange (AMEX) Regional Stock Exchanges (Chicago, San Francisco, Philadelphia, Boston, etc.) Over-the-Counter Exchange NASDAQ

21 A Sample Stock Transaction
Market Order Day Order Week Order (Good This Week, GTW) Month Order (Good This Month, GTM) Limit Order Stop Order

22 Long-Term Investment Strategies
Buy-and-Hold Technique Dollar Cost Averaging Value Cost Averaging

23 Direct Investment and Dividend Reinvestment Plans
Direct Investment Plan allows you to purchase stock directly from a corporation without having to use an account executive or a brokerage firm. Dividend Reinvestment Plans (DRIP) allows you the option to reinvest your cash dividends back into your portfolio to purchase additional shares of stock.

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