1. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company1 What is it? Common stock represents an ownership interest in a corporation. –Each shareholder is entitled to a proportionate share of the control, profits, and assets of the corporation. Shareholders exercise control through voting rights. They receive a share of corporate profits through dividends. –If the corporation is sold or liquidated, owners of common stock will share the net proceeds.

2. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company2 When is the use of this tool indicated? When an investor is willing to accept the risk of fluctuating share prices in return for potential capital growth and increasing dividend income When the investor is concerned that the purchasing power of fixed income securities may not keep pace with inflation

3. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company3 Advantages Over the long run, common stocks have provided an average annual rate of return almost twice that of fixed income investments. –Over the past 50 years: Return on stocks have averaged 9% to 10%. Return on fixed income securities have averaged 4%. –From 1996 to 2005, the S&P 500 Stock Index averaged a compound annual rate of return of 9.02%. Common stocks are highly marketable. –They can quickly and easily be converted to cash if necessary. –This liquidity itself enhances their value.

4. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company4 Advantages Investors are able to select securities that are compatible with their own particular investment requirements and risk- taking preferences. –This is due to the huge number of common stocks available. Common stocks do not require personal involvement in the day-to-day management of the enterprise. –However, the time an investor spends on managing his or her own portfolio depends on: Personal preference and investment style Availability of time The degree of knowledge and skill of the investor

5. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company5 Disadvantages The market prices of stocks can fluctuate widely over time. –Day-to-day changes in share prices are inevitable and beyond the investor’s control. –This volatility may be unsettling to conservative investors for whom preservation of capital is a high priority. The prices of individual securities may be adversely affected by factors unrelated to the financial condition of the business itself, including: –Political events –Changes in tax laws or interest rates –General economic conditions

6. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company6 Disadvantages It is possible that an investor could lose all or a significant portion of his investment. Payment of dividends on common stock is not guaranteed. –Declaration of a dividend, as well as the specific amount, is at the discretion of the corporation’s board of directors. Traditionally, many corporations have paid regular dividends. –Dividends may vary with changes in the general financial condition of a company. This would be a potential problem for investors who desire a regular income.

7. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company7 Tax Implications Dividends are generally taxed as ordinary income. –Under JGTRRA 2003, “qualified dividend income” is treated as net capital gain and is subject to lower tax rates. Generally, “qualified dividend income” includes dividends paid by domestic corporations and certain foreign corporations to shareholders. For taxpayers in the 25% income tax bracket and higher, the maximum rate on qualified dividends paid by corporations to individuals is 15% in 2003 through 2010. After December 31, 2010, dividends will once again be taxed at ordinary income tax rates.

8. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company8 Tax Implications Capital gains are taxable at various rates depending on the holding period of the investment. –Short-term gains (holding period of 12 months or less ) are taxable at ordinary income tax rates up to a maximum of 35%. –Long-term gains (holding period of more than 12 months) are taxable at: A 5% rate for investors in the 10% or 15% brackets –Applies in 2003 through 2007; 0% in 2008 through 2010 A 15% rate for investors in all other brackets –Applies in 2003 through 2010 After December 31, 2010, the lower capital gains rates will revert to 10% and 20%, respectively.

9. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company9 Tax Implications Losses on the sale of common stock will be short-term or long-term depending on the holding period. –Capital losses are deductible dollar-for-dollar against short-term capital gain, long-term capital gain, and, to a limited degree, against ordinary income. The maximum amount of ordinary income that may be offset in one tax year is $3,000; any excess capital loss may be carried over to the succeeding tax year. –Qualified dividend income, which is treated as net capital gain under JGTRRA 2003, is not eligible to offset capital losses.

10. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company10 Example Assume Dick Goldman had a capital “paper loss” of $8,000 and an actual realized short-term gain of $5,000 in the same year. If he sold the depressed shares and recognized the $8,000 loss, $5,000 of the loss would be used to wipe out the entire short-term gain. This would leave a $3,000 loss that could be used to reduce his ordinary income.

11. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company11 Tax Implications Year-to-year appreciation in share prices is not taxable unless and until the investor realizes the gain by: Selling the stock Otherwise disposing of it in a taxable transaction –It is possible to defer the gain until a tax year in which the investor is in a lower tax bracket. –If an investor holds appreciated stock until his death, the gain is never taxed. The “basis” of the stock is “stepped-up” to its fair market value for federal estate tax purposes.

12. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company12 Example Bob Norton purchased stock for $30 per share, and it is worth $130 per share at the time of his death. The new basis of the stock in his executor’s hands would be “stepped-up” to $130. If the executor sold the stock the next day for $130, there would be no gain. This is because the “amount realized” ($130) minus the adjusted basis ($130) would be zero and, therefore, there would be no taxable gain.

13. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company13 Alternatives Certain types of real estate investments offer similar features in regard to: –Capital gain potential –Deferral of taxation –The opportunity for increasing income over time Convertible Bonds –Interest income will generally be greater than the dividends paid on common shares of equal value. –The conversion feature offers the potential for bondholders to share in the future appreciation of common stock. Securities Options (“Puts” and “Calls”) –Provide the opportunity for substantial leverage based on a relatively small capital outlay.

14. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company14 Where and How do I get it? Common stocks are typically purchased through a stock brokerage firm. –Once an account is established by providing certain personal and financial information, brokers will transact orders for the purchase or sale of shares. Banks, mutual funds, and other financial institutions –May not provide the full range of services offered by the typical brokerage firm –They generally charge substantially lower commissions to buy and sell shares Electronic trading –Often done through discount brokerage firms or electronic communication networks (ECNs) –Such transactions have very low costs Fees paid on these trades can be as low as $4.

15. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company15 Where and How do I get it? Once stock has been bought or sold, the investor is notified by mail in the form of a written confirmation, which confirms: –The date of the transaction –The name of the company involved –The number of shares –The transaction price per share –The total value of the transaction –The commissions or fees charged

16. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company16 Where and How do I get it? The ownership of stock is evidenced by certificates. –Investors can have their broker send them the actual stock certificates. –The broker can also hold them for safekeeping. This relieves the investor of the expense and trouble of providing security for the shares. It also makes it easier and faster to sell the shares at a later date. –When shares are held by the broker on behalf of the investor, it is known as holding shares in “street name.” The shares are registered in the name of the broker. Any dividends paid on the stock are remitted to the brokerage firm that will pay them to the investor or retain them in the investor’s account.

17. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company17 Where and How do I get it? Many investor’s prefer to own common stocks indirectly through mutual funds. These funds provide a number of advantages, such as, –Diversification –Professional management –Automatic reinvestment of dividends –Ease of record keeping

18. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company18 What fees or other costs are involved? Brokerage commission or fee –The sales charge associated with purchasing common stocks directly from a broker or a bank –The amount of the fee is dependent upon: The amount invested The number of shares purchased –Investors should compare the rates charged by various sources when buying or selling shares. Commission charges vary widely. –Transactions costs are not the only factor to consider. The information, advice, and other services provided by a firm may easily justify a higher commission rate.

19. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company19 How do I select the best of its type? Professional security analysts rate common stocks according to their: –Overall quality –Security –Growth potential The process involves an analysis of various factors, such as: –Product and industry position –Corporate resources –Financial policy Rating Services –Standard & Poor’s: www.standardandpoors.comwww.standardandpoors.com –Moody’s: www.moodys.comwww.moodys.com –Value Line Investment Survey: www.valueline.comwww.valueline.com –Morningstar: www.morningstar.com

20. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company20 How do I select the best of its type? Extensive information and investment advisory services are offered by most brokerage firms. –They can provide recommendations on specific industries or individual companies in the form of research reports by their own analysts. –They also make available information that they in turn purchase from one or more professional research firms. A company’s “annual report” –Contains information on the company’s activities, its financial condition, products or services, general outlook, management personnel, dividend payments, and future prospects –A more detailed version (“10-K report”) can be obtained from the company or SEC Investors seeking current income should examine the dividend payment record of the stock in question.

21. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company21 Where can I find out more about it? A local library will often have access to rating services, books on investments, periodicals such as the Wall Street Journal, and annual reports. Major newspapers which carry daily listings of the trading activity on the larger stock and bond exchanges. –The Wall Street Journal –The New York Times Major brokerage firms and the trust departments of many banks can often provide research reports and other information on specific issues and current market conditions.

22. Common Stocks Chapter 10 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company22 Where Can I Find Out More About it? Internet resources –Most larger companies and many smaller ones provide their annual reports, press releases, and other useful information electronically. –The Electronic Data Gathering, Analysis, and Retrieval (EDGAR) website provided by the SEC: www.sec.gov/edgarhp.htm www.sec.gov/edgarhp.htm –Others include: Bloomberg: www.bloomberg.comwww.bloomberg.com Yahoo: www.finance.yahoo.comwww.finance.yahoo.com