Chapter 14: Investing in Stocks

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.

Common stock  Voting rights  Proxy Vote  Can receive dividends Preferred stock  Cumulative  Convertible  Callable?? Stocks and Bonds and How They are Used

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

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 Investing in Stocks

Why Invest in Stocks? 1. Over time, common stocks outperform all other investments. In the chart above the red line shows the growth of $100 invested in the Dow Jones Index at year-end 1928, with dividends reinvested through year-end The blue line shows the growth of the Shiller residential real estate price index during the same period, assigning 1928 a base value of 100. All amounts are in "then current" dollars -- i.e., not constant dollars

2. Stocks reduce risk through diversification. 3. Stocks are liquid. 4. The growth in your investment is determined by more than just interest rates. Why Invest in Stocks?

Why Do Investors Purchase Stock? Income from dividends  Record Date  Declaration Date  Ex-dividend Date  2 nd bus. Date before date of record. Dollar appreciation of stock value Increased value from stock splits

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 PurchasedReturn when Sold 100 $42.75 = $4, $56.25 = $5,625 Plus commission + 29Minus commission - 34 Total investment $4,304Total return $5,591 Transaction Summary Total return $5,591 Minus total investment- 4,304 Profit from stock sale$1,287 Plus dividends+ 221 Total return for the transaction$1,508

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

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

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

Types of Stock Investments 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 (continued)

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 quote.yahoo.com and smartmoney.com

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

Numeric Measures to Consider When Evaluating a Stock 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 (continued)

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

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 = $2.50 = 20

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 = $1.44 = 0.28 = 28%

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 = $10.00 = 0.04 or 4%

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

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

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

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.

Dollar Cost Averaging vs Value Averaging Dollar Cost AveragingValue Averaging Period Market Price Amount Invested Shares Purchased Shares Owned Amount Required Shares Purchased Shares Owned Amount Invested Q1 $ $ 1, , $ 1,000 Q2 $ , , Q3 $ , , ,720 Q4 $ , , $ 4,000 $ 3,720 Avg Cost Total Cost Current Value Current Gain DCA $ 9.88 $ 4,000 $ 4,050 $ 50 VA $ 9.30 $ 3,720 $ 4,000 $ 280