1. 1 Chapter 13 - Stock Purchase stock = buy part of company Returns from dividends and capital appreciation –Dividends – distribution of profits –Neither dividends nor appreciation guaranteed Why invest in stocks? –Over time, outperform other investments, provide diversification, and are liquid

2. 2 Annual Rates of Return 1926 to 2000 Avg Ann Stand Risk Security Returns Dev Prem Small Co Stocks 17.3% 33.4% 13.4% Common Stock 13.0 20.2 9.1 L-T Corp Bonds 6.0 8.7 2.1 L-T Govt Bonds 5.7 9.4 1.8 Med-term Govt 5.5 5.8 1.6 US T-Bills 3.9 3.2 0 Inflation 3.2 4.4

3. 3 Terminology Limited liability – stockholder not liable for firm's debts Claim on income (after all expenses paid) but board decides to pay dividends Dividends – 75% pay, usually quarterly Voting rights – shareholders elect directors and approve changes in governing rules –Vote through proxies

4. 4 Proxy Statement Proxy – gives instructions on how to vote your shares Annual meeting – elect some directors, appoint auditors; sometimes approve option plans, new shares, merger, etc Statement – discusses directors, executive comp, stock performance versus index

5. 5 Terminology II Splits – new shares issued on pro rata basis –No economic impact Share repurchases returns funds to shareholder; accomplishes other objectives

6. 6 Stock Indexes Measure general market performance –DJIA (30 companies), S&P 500 and others Bear market – falling prices; bull market rising prices Stock prices now decimalized; previously fractions of a dollar

7. 7 Classifications Blue-chips Growth stocks Speculative issues Cyclical stocks Defensive stocks Large caps

8. 8 Valuing Stocks Technical analysis – supply and demand; charts used to predict trends –Author: Little value, other strong believers Price/ earnings ratios –Price / EPS – forward and backward looking –Positive about prospects, have high P/E –Dividend yield – about 1.6%

9. 9 Top-Down Analysis Economic  Industry  Fundamentals Economic Analysis Fiscal & Monetary, Other (inflation, etc) Industry as a whole: Growing? Competitive? Technology? Cyclical? Company Fundamentals - Performance and position in industry, results 

10. 10 Discounted Dividend Valuation Present values all future dividends –Dividends – an infinite stream –Assumed to grow at constant rate forever –Need to estimate future dividends and investors' required rate Market value = Dividend Next Year Required rate less growth rate How can you value a non-dividend stock?

11. 11 Why Stocks Fluctuate Interest rate changes –Inverse relation between rate change and price change –Rates rise, present value of dividend and price both fall Risk – more risky, price falls Outlook for company and economy.

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13. 13 Common Sense Advice Don'ts when stocks tumble: –Don't make impulsive decisions –Don't ignore taxes –Don't listen to pundits –Don't count you losses because they are meaningless until you sell.

14. 14 Strategies Dollar cost averaging – buy fixed amount at regular intervals Buy and hold – Why? –Can't time the market, minimizes broker fees Dividend Reinvestment Plans (DRIP's) –Dividends automatically reinvested in the stock –Taxed on dividend even if get no cash

15. 15 Stocks and the 15 Principles #1. Risk-return tradeoff – stocks on the upper end of the risk/return line #3 Diversification reduces risk – find investments that don't move together #4 Not all risk is equal – can reduce company specific risk but not market risk #11 Time – long horizon, can take more risk. See Figure 13.7