Introduction to Stocks and Investing

Introduction to Stocks and Investing

Objectives Explain What is a Stock Explain the Types of Stocks
Explain the Classification of Common Stock Describe the Role of Beta in Your Portfolio List the Various Stock Screening Criteria Explain the Types of Analysis in Stock Trading Explain the Ratios for Valuing Firms List the Criteria for Choosing a Broker Explain the Common Stock Investing Strategies Explain the Steps of a Typical Stock Transaction Explain How to Read Stock Quotations Explain the Calculation of Price-to-Earnings Ratio (PE) Explain the Key Terms of Stocks and Investments Describe the Rights of a Stockholder Describe the Various Investment Options

Peter Looney works as an executive.
Introduction Peter Looney works as an executive. For a long time, Peter has felt that he should invest the extra amount of money that he makes from his job.

Introduction He has been saving in cash form for a long time.
However, he wants that he should use the saved amount to invest in something that could help him multiply his money and help grow his finances.

Introduction Peter has always thought of starting a business venture to grow his money, however, he is greatly averse to the huge amount of risk involved in any business venture. So, Peter starts asking advice from his colleagues about what possible investment options are available in the market.

Introduction George, one of Peter’s colleagues, advices him to invest in stocks and mutual funds. Stocks are the capital raised by a corporation through the issue of shares entitling holders to an ownership interest also known as ‘equity’.

Introduction Mutual funds are an investment vehicle made of pool of funds collected through a regulated investment company from many investors. This pooled money is then used for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.

Introduction Money managers operate the mutual funds by investing the fund's capital and attempt to produce capital gains and income for the fund's investors. George tells Peter that by investing in stocks and mutual funds, Peter can earn a small share of the great profits that big and successful organizations make for themselves and their shareholders.

Introduction George tells him that although Peter will get to enjoy a part of the profit made by the organization, he will be spared of the hassles of running a business on his own, and also will undertake a much lesser risk than if he would have to run a business on his own. Therefore, although stocks and mutual funds would help Peter to multiply and grow his money, he would be able to do so by taking advantage of the stability and experience of these fast growing and stable organizations that have been operating and making profits for decades.

Introduction George also adds a word of warning for Peter.
He tells Peter that the most important thing that he should keep in mind while investing in stocks and mutual funds is that he should determine the maximum risk that he is willing to take.

Introduction Peter should always make sure that he never invests more than his risk taking capacity. George assures Peter that if he takes calculated risks and invests wisely; then stocks and mutual funds prove to be a very lucrative way of growing his money.

Introduction Therefore, you can understand that investing in stocks and mutual funds are a great way to multiply and grow your money by undertaking calculated amount of risk according to one’s own risk taking capacity. Let us learn about stocks and investing in detail.

What is a Stock? Any business needs money or capital whenever it has to start its operations or expand its business operations. Thus, in order to raise this capital for a business start-up or expansion, the corporation would offer shares of stock for sale to the public.

What is a Stock? By selling these shares or stock to the public, the company is able to increase its finance reserves and also get the necessary funds to start operations or expand its operations. So, any individual who purchases a ‘share’ or ‘stock’ of a company becomes a part owner of a portion of that company, based upon the number of shares purchased compared with the number of shares that make up the company’s total stock offering.

What are Stock Exchanges?
The trading of stocks at both national and international level is carried out on several exchanges known as ‘Stock Exchanges’. The determination of which stock exchange the stocks of a company would be traded on depends on the size of the corporation and the location of the company’s headquarters.

What are Stock Exchanges?
The stocks listed on these stock exchanges are traded by licensed brokers who work for stock brokerages. ‘Stock brokerage’ pays a fee to the exchange to maintain a seat there for the privilege of buying and selling securities.

Why Stocks should be in Your Portfolio?
It has been found over several decades that, as an asset class, common stocks have outperformed all other major asset classes. Also, stocks deliver strong long-term capital gains. They prove to be one of the best and most tax-efficient types of return.

Why Stocks should be in Your Portfolio?
You should include stocks in your diversified portfolio because the individual stocks in a diversified portfolio can reduce the overall risk of your portfolio. Dividends and capital gains are taxed at a lower preferential federal tax rate and so if tax planning is done wisely, then stocks can prove to be tax-efficient assets.

1 2 Types of Stocks Common Stock Preferred Stock
There are two main types of stocks that are offered by any company such as follows: Let’s look at each in detail.

1 Common Stock Common Stock
Common Stock is a ‘voting stock’. Hence, any individual who has purchased the common stock of a company is entitled to vote for appointing the officers of the company and it’s Board of Directors. Thus, common stock is the ownership share in publicly held company. Common stock holders have a residual claim on a company’s assets. Each common stockholder or shareholder of a corporation is entitled to certain rights and obligations. Thus, each common stockholder has the right to vote. Moreover, if a common stockholder is not able to vote in person, he can give a written consent to give permission to someone else to vote on his behalf as a proxy.

1 Common Stock Common Stock
Also, a common stockholder has a right to limited liability. Hence, in cases where the corporation is found liable for an act, the shareholders cannot be held responsible. One of the greatest benefits of common stock ownership is that such stockholders may receive payment of a stock dividend. So, instead of receiving cash for your shares, you receive additional shares in the company’s stock. Moreover, a common stockholder also enjoys certain other privileges. So, if the company decides to sell additional shares of stock, common shareholders have certain pre- emptive rights which entitle them to purchase the shares before they are offered to the public. Common Stock is a ‘voting stock’. Hence, any individual who has purchased the common stock of a company is entitled to vote for appointing the officers of the company and it’s Board of Directors. Thus, common stock is the ownership share in publicly held company. Common stock holders have a residual claim on a company’s assets. Each common stockholder or shareholder of a corporation is entitled to certain rights and obligations. Thus, each common stockholder has the right to vote. Moreover, if a common stockholder is not able to vote in person, he can give a written consent to give permission to someone else to vote on his behalf as a proxy.

2 Preferred Stock Preferred Stock
‘Preferred Stock’ as the names suggests has a preferential position over common stock. Therefore, during the payout of dividend to share holders, it is first paid to preferred stock owners before common stock holders. Preferred stock is also ownership shares of a company. However, it differs from common stock because in preferred stocks, the dividend is guaranteed and paid before dividends on common stock are paid. On the other hand, if profits of the company increase, the dividend for preferred stocks isn’t increased accordingly.

2 Preferred Stock Preferred Stock
‘Preferred Stock’ as the names suggests has a preferential position over common stock. Therefore, during the payout of dividend to share holders, it is first paid to preferred stock owners before common stock holders. Preferred stock is also ownership shares of a company. However, it differs from common stock because in preferred stocks, the dividend is guaranteed and paid before dividends on common stock are paid. On the other hand, if profits of the company increase, the dividend for preferred stocks isn’t increased accordingly. The major benefit of preferred stock is that it pays a fixed cash flow to investor and ensures a steady dividend stream. Owners of preferred stock investors face great risks such as that of interest rate risk, call risk and default risk.

Key Asset Classes for Common Stocks
The following are some of the key asset classes for common stocks: Small Capitalization / Small Cap Stocks Mid Capitalization / Mid Cap Stocks Large Capitalization / Large Cap Stocks

Key Asset Classes for Common Stocks
The following are some of the key asset classes for common stocks: Large Cap stocks are stocks of companies with market capitalization (shares outstanding times’ price) of greater than $10 billion. Small Capitalization / Small Cap Stocks Mid Capitalization / Mid Cap Stocks Large Capitalization / Large Cap Stocks Small Cap stocks are stocks of companies with market capitalization of less than $2 billion. Mid Cap stocks are stocks of companies with market capitalization of between $2 billion and $10 billion.

Classification of Common Stock
Common stock can be classified as follows: Blue-chip Stocks Growth Stocks Value Stocks Income Stocks Cyclical Stocks Defensive Stocks Let us look at each in detail.

Blue-chip Stocks Blue-chip Stocks:
‘Blue Chip Stock’ is a stock that is issued by a large, stable, mature company. This is not a specific list, but changes over time.

Growth Stocks Growth Stocks:
‘Growth Stock’ is the stock that compensates investors primarily through increase in value of the shares over time. These are issued by companies which are growing faster than average and which generally reinvest dividends. They generally have higher PE and PB ratios than the market as a whole.

Value Stocks Value Stocks:
Value Stocks are issued by companies which are less expensive compared to the market. They generally have lower PE and PB ratios than the market as a whole.

Income Stocks Income Stocks:
‘Income Stock’ is the stock that compensates investors primarily through the regular payment of dividends. These are issued by companies which pay dividends regularly.

Cyclical Stocks Cyclical Stocks:
‘Cyclical Stock’ is stock exhibiting above-average sensitivity to the business cycle. These are issue by companies whose share prices move up and down with the state of the economy.

Defensive Stocks Defensive Stocks:
‘Defensive Stock’ is a stock that is relatively insensitive to the business cycle. These are issued by companies whose share prices move opposite to the state of the economy.

Click on the radio button to select the correct answer!
MCQ Q. Which of the following is a stock issued by a large, stable and mature company? Click on the radio button to select the correct answer!

MCQ Good! That's Right! Correct Answer: ‘Blue Chip Stock’ is a stock that is issued by a large, stable and mature company. Q. Which of the following is a stock issued by a large, stable and mature company? Click here to Continue!

MCQ That's Not Quite Right!
‘Blue Chip Stock’ is a stock that is issued by a large, stable and mature company. Q. Which of the following is a stock issued by a large, stable and mature company? Click here to Continue!

What is ‘Beta’? ‘Beta’ is one of the most important concepts
that you need to understand while trying to learn about stocks and investments. ‘Beta’ is an important indicator of how susceptible a stock is to movements of the market. Therefore, ‘Beta’ indicates the sensitivity of a stock to movements in the overall market.

Interpreting Beta It is very important that you understand how to interpret ‘Beta’ to understand how a stock is behaving with respect to the movements in the overall market.

Interpreting Beta The following are some important points that you should bear in mind while interpreting ‘Beta’: If Beta = 1.0 = This means that the stock has the same risk as the market. Therefore, a stock with Beta = 1 will move with the market. If Beta > 1.0 = This means that the stock has more risk than the market. Therefore, a stock with Beta > 1.0 will move more than the market. If Beta < 1.0 = This means that the stock has less risk than the market. Therefore, a stock with Beta < 1.0 will move less than the market.

Role of Beta in Your Portfolio
• • • So, this weighted ‘Beta’ or the ‘Beta of your portfolio’ will indicate and show you how risky your portfolio is versus the market. The ‘Beta’ indicator plays a crucial role while selecting the stocks that will make up your portfolio. Hence, when you build a portfolio, you should always track the beta of your portfolio. The ‘Beta’ of your portfolio is the weighted Beta of each of your stocks or funds in the portfolio.

Role of Beta in Your Portfolio
• • • • You should always keep in mind that a diversified portfolio moves with the market. So, in a diversified portfolio, you will feel less effect from one company. Hence, it is crucial that you should always be diversified in all your investments. So, you should diversify by buying a broad array of financial assets. You should not only invest in large-capitalization stocks, but also broaden and deepen your portfolio by buying international stocks, small cap stocks, etc.

1 2 3 Understanding Leverage
‘Leverage’ is another important concept while learning about stocks and investing. ‘Leverage’ is the process of increasing your purchasing power by borrowing money to invest in more assets. 2 Therefore, it is very natural that the ‘Leverage’ increases your risk as you invest more than your own financial capacity by borrowing from others. 3 Also, when you borrow money for investing the rate of return on the loan is fixed, however, there is no fixed or guaranteed rate of return on your investments.

4 5 6 Understanding Leverage
Therefore, Leverage magnifies capital gains and losses. 5 As a ground rule, you should always keep in mind that you should ‘never’ use leverage to invest. Leverage is as pure and simple as an ordinary ‘debt’. 6 So, if you want to invest a larger amount, then the best thing that you can do is saving for making the larger investments but never borrow money for it.

Costs of Investing in Stocks
It is crucial for you to understand that there are a few major costs of investing in stocks. Also, the costs of investing in stocks can be divided into the following three major types: Explicit Costs Implicit Costs Hidden Costs Let us look at each in detail.

Brokerage Commission Costs and Fees
Explicit Costs Explicit Costs ‘Explicit Costs’ includes the costs that are reflected in and you see each month in your financial statement. Therefore, ‘Explicit Costs’ include: Brokerage Commission Costs and Fees Custody or Annual Fees Let us look at each in detail.

Explicit Costs Explicit Costs
‘Explicit Costs’ includes the costs that are reflected in and you see each month in your financial statement. Therefore, ‘Explicit Costs’ include: Brokerage Commission Costs and Fees Brokerage Commission Costs and Fees Brokerage Commission Costs and Fees: ‘Explicit Costs’ include the brokerage commission costs and fees. Brokerage commission costs and fees is a service charge applied by a broker in return for arranging the purchase or sale of financial assets. Custody or Annual Fees Let us look at each in detail.

Explicit Costs Explicit Costs
‘Explicit Costs’ includes the costs that are reflected in and you see each month in your financial statement. Therefore, ‘Explicit Costs’ include: Brokerage Commission Costs and Fees Brokerage Commission Costs and Fees You should bear in mind that the brokerage fees and commissions vary widely from broker to broker. Also, the brokerage commission or fees may be calculated and set in various ways. For example: A broker may charge a fixed amount of $12 per trade or he may charge a percentage of the purchase or sale price such as 0.75% for both buying and selling. Brokerage Commission Costs and Fees: ‘Explicit Costs’ include the brokerage commission costs and fees. Brokerage commission costs and fees is a service charge applied by a broker in return for arranging the purchase or sale of financial assets. Custody or Annual Fees Let us look at each in detail.

Explicit Costs Explicit Costs ‘Explicit Costs’ includes the costs that are reflected in and you see each month in your financial statement. Therefore, ‘Explicit Costs’ include: Brokerage Commission Costs and Fees Custody or Annual Fees: ‘Explicit Costs’ include custody or annual fees. Custody or annual fees are fees the brokerage house charges to hold the stocks, bonds, or mutual funds in your account. Custody or Annual Fees Custody or Annual Fees Let us look at each in detail.

Explicit Costs Explicit Costs ‘Explicit Costs’ includes the costs that are reflected in and you see each month in your financial statement. Therefore, ‘Explicit Costs’ include: Brokerage Commission Costs and Fees Also, the custody or annual fees may be calculated and set in various ways. For example: A brokerage house may charge a fixed amount such as a minimum amount for small accounts such as $12 per year, or it may charge a specific charge per holding such as 0.18% per security, or a certain percentage of assets under management. Custody or Annual Fees: ‘Explicit Costs’ include custody or annual fees. Custody or annual fees are fees the brokerage house charges to hold the stocks, bonds, or mutual funds in your account. Custody or Annual Fees Custody or Annual Fees Let us look at each in detail.

Implicit Costs Implicit Costs
‘Implicit Costs’ are the taxes that you pay. Hence, it is crucial that you should take into account these ‘implicit costs’ as these are critical costs that must be taken into account to get the true return of your portfolio but which are not noted on your monthly financial reports. The following are some of the ‘Implicit Costs’ that you may have to pay: Capital Gains Taxes Short-term Capital Long-term Capital Dividends Let us look at each in detail.

‘Implicit Costs’ are the taxes that you pay. Hence, it is crucial that you should take into account these ‘implicit costs’ as these are critical costs that must be taken into account to get the true return of your portfolio but which are not noted on your monthly financial reports. The following are some of the ‘Implicit Costs’ that you may have to pay: Capital Gains Taxes Capital Gains Taxes Short-term Capital Long-term Capital Capital Gains Taxes: You may have to pay taxes on the gains you have made by selling financial assets. Dividends Let us look at each in detail.

‘Implicit Costs’ are the taxes that you pay. Hence, it is crucial that you should take into account these ‘implicit costs’ as these are critical costs that must be taken into account to get the true return of your portfolio but which are not noted on your monthly financial reports. The following are some of the ‘Implicit Costs’ that you may have to pay: Capital Gains Taxes Short-term Capital Short-term Capital Long-term Capital Short-term Capital: You may have to pay taxes on the gains that you made in selling assets owned for a period of less than one year. Dividends Let us look at each in detail.

‘Implicit Costs’ are the taxes that you pay. Hence, it is crucial that you should take into account these ‘implicit costs’ as these are critical costs that must be taken into account to get the true return of your portfolio but which are not noted on your monthly financial reports. The following are some of the ‘Implicit Costs’ that you may have to pay: Capital Gains Taxes Short-term Capital Long-term Capital Long-term Capital Long-term Capital: You may have to pay taxes on the gains that you made in selling assets owned for a period of more than one year. Dividends Let us look at each in detail.

‘Implicit Costs’ are the taxes that you pay. Hence, it is crucial that you should take into account these ‘implicit costs’ as these are critical costs that must be taken into account to get the true return of your portfolio but which are not noted on your monthly financial reports. The following are some of the ‘Implicit Costs’ that you may have to pay: Capital Gains Taxes Short-term Capital Dividends: You may have to pay taxes for the dividends that you receive from the companies. Dividends are the returns you get from the company. Different countries have different rules and policies for taxing stock dividends, bonds and other dividends at federal tax rate and your state marginal tax rate. Long-term Capital Dividends Dividends Let us look at each in detail.

Account Maintenance Fees Interest on Margin Loans
Hidden Costs Hidden Costs ‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Inactivity Fees Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs ‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Transfer Fees Account Maintenance Fees Inactivity Fees Account Transfer Fees: ‘Account Transfer Fees’ are the charges that you need to pay for moving assets either into or out of an existing account. Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs
‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Account Maintenance Fees Inactivity Fees Account Maintenance Fees: ‘Account Maintenance Fees’ are the charges that you need to pay for maintaining your account. Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs ‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Inactivity Fees Inactivity Fees Inactivity Fees: ‘Inactivity Fees’ are the charges that you need to pay because you did not trade or did not perform any account activity during a specified period. Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs ‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Inactivity Fees Minimum Balance Fees: ‘Minimum Balance Fees’ are the charges that you need to pay because you failed to maintain a minimum balance in your account. Minimum Balance Fees Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs
‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Inactivity Fees Interest on Margin Loans: ‘Interest on Margin Loans’ is the amount that you need to pay as an ‘interest’ on money you borrowed to buy securities. Minimum Balance Fees Interest on Margin Loans Interest on Margin Loans Sales Charges or Loads Let us look at each in detail.

Hidden Costs Hidden Costs ‘Hidden Costs’ are the costs that you have to bear while investing in stocks that are not included in the ‘Explicit Costs’ and the ‘Implicit Costs’. Some of the ‘Hidden Costs’ that you should look out for while investing in stocks are as follows: Account Transfer Fees Account Maintenance Fees Inactivity Fees Sales Charges or Loads: ‘Sales Charges or Loads’ are the sales charges that you need to pay to the broker for helping you purchase specific securities such as mutual funds. Minimum Balance Fees Interest on Margin Loans Sales Charges or Loads Sales Charges or Loads Let us look at each in detail.

Political or Regulatory Risk
Risks in Stocks You should always bear in mind while investing stocks that all kinds of stocks are susceptible to a number of risks. Moreover, the amount of risk may not be equal in all stocks. The following are the major types of risks faced by stocks: Interest Rate Risk Inflation Risk Business Risk Financial Risk Liquidity Risk Political or Regulatory Risk Exchange Rate Risk Market Risk Let us look at each in detail.

Interest Rate Risk Interest Rate Risk Interest Rate Risk:
‘Interest Rate Risk’ is the risk caused by the rise or fall in interest rates which may result in a decline or rise in the stock’s value.

Inflation Risk Inflation Risk Inflation Risk:
‘Inflation Risk’ is a risk caused due to a rise or fall in inflation which will result in a decrease or increase in the value of the stock.

Business Risk Business Risk Business Risk:
‘Business Risk’ is risk that the share price will fall due to problems with the business.

Financial Risk Financial Risk Financial Risk:
‘Financial Risk’ is a risk is caused due to any adverse effect caused on the financial performance of the firm due to ways in which the firm raises money.

Liquidity Risk Liquidity Risk Liquidity Risk:
‘Liquidity Risk’ is a risk that investors will be unable to find a buyer or seller for a stock when they need to sell or buy that particular stock.

Political or Regulatory Risk
‘Political or Regulatory Risk’ is a risk that unanticipated changes in the tax or legal environment will have an adverse impact on a business.

Exchange Rate Risk Exchange Rate Risk Exchange Rate Risk:
‘Exchange Rate Risk’ is a risk that changes in exchange rates will impact the profitability of firms that operate and function on a global or international level.

Market Risk Market Risk Market Risk:
‘Market Risk’ is risk of the impact on price due to the overall market movements.

Stock Market Sectors When deciding to buy or sell any stock, it is crucial that you should have thorough knowledge about the sector of the particular stock that you intend to buy or sell. The performance of the overall sector in the economy will to a greater extent affect the stocks of the company belonging to that particular sector.

You should always be aware of which sectors are doing well.
Stock Market Sectors The following are some considerations that you should keep in mind with respect to the sector of any company: You should always be aware of which sectors are doing well. You should always be aware of which sectors are not doing well. Keep a track of the performance history of the various sectors to determine the high performing sectors. You should always be aware of what are the new rules and regulations that have come up in different sectors of the economy in your country. Always keep abreast of the latest news and trends with respect to the different sectors.

Stock Market Sectors The given image shows the various sectors in an economy of any country:

Stock Screening Criteria
It is very important that you should screen each and every stock that you intend to buy or sell before deciding on a purchase or sale. Screening the stock carefully on certain crucial criteria will help you make informed and wise decision to safeguard your money against risk as well as losses.

Price-to-Earnings (P/E) Ratio
Stock Screening Criteria The following are some of the crucial criteria that you should screen the stock upon: 52-Week Price Change Dividends Exchange Sector Price-to-Earnings (P/E) Ratio Market Cap Daily Volume

Stock Split ‘Stock Split’ is a process through which a company splits its own shares to keep the price of its stock affordable and in a buying range. Generally, a stock price of $6-$100 per share is considered affordable. A company may decide to split each of its shares into a number of shares. So, a company may split its stock (x) for 1, which results in the stock price declining by the same multiple (x). You should bear in mind that a stock split has no impact on firm value, but it may give information on the firm’s prospects.

Stock Split For Example:
Assume you had 20 shares priced at $100 each or 20 * $100 = $2,000. If the stock split 2 for 1, you would have 40 shares (2 * 20) and the price would adjust to $50 each, or 100 / 2. Your value would be 40 * $50 = $2,000, the same as before

Reverse Split A ‘Reverse Split’ is the opposite of a stock split.
A reverse split is carried out by a company if the company’s stock price is too low. So, a company may do a reverse split to reduce the number of shares outstanding and raises the stock price.

Let us now look at a real life example to understand stock splitting.

Real Life Example Peter Smith owns 300 shares of Globus Stock selling at $600 per share. At a recent Board Meeting, Globus’ management has decided to split the stock, in order to make the stock more affordable for the average investor.

Real Life Example Look at the questions given below and try answering them in context of the changing situations at Globus. How much was Peter’s investment before the split? Consider that Globus’ management decides to split the stock three-for-one, how many shares would Peter own after the split? What is the new price per share after the split? How much would Peter’s investment be worth after the three -for-one split? Now, let’s take a look at the answers.

Real Life Example Look at the questions given below and try answering them in context of the changing situations at Globus. How much was Peter’s investment before the split? Consider that Globus’ management decides to split the stock three-for-one, how many shares would Peter own after the split? What is the new price per share after the split? How much would Peter’s investment be worth after the three -for-one split? Now, let’s take a look at the answers. How much was Peter’s investment before the split? Peter’s investment before the split = 300 shares x $600 per share = $180,000. Consider that Globus’ management decides to split the stock three-for-one, how many shares would Peter own after the split? Number of shares that Peter would have after the three-for-one split = 300 x 3 = 900 shares.

How much was Peter’s investment before the split?
Real Life Example How much was Peter’s investment before the split? Peter’s investment before the split = 300 shares x $600 per share = $180,000. Consider that Globus’ management decides to split the stock three-for-one, how many shares would Peter own after the split? Number of shares that Peter would have after the three-for-one split = 300 x 3 = 900 shares. What is the new price per share after the split? New price per share after the split = $600/3 = $200. How much would Peter’s investment be worth after the three -for-one split? Peter’s investment worth after the three -for-one split = 900 shares x $200 per share = $180,000. Therefore, Peter’s investment worth after the three -for-one split remains the same as his initial investment amount.

Analysis in Stock Trading
Before trading in stocks, various kinds of analysis is carried out by investors, financial experts, financial institutions, etc. to give an indication about the performance of a stock, its volatility etc. The following are a few key types of analysis performed on stocks: Fundamental Analysis Cash Flow Analysis Technical Analysis Let us look at each in detail.

Fundamental Analysis Fundamental Analysis
The chief assumption on which ‘Fundamental Analysis’ is carried out is that the value of the stock can be determined based on the future earnings of the company. Financial Analysts carry out thorough research on the background and operations of a company, the state of the industry to which the company belongs, the global industry and the global economy etc.

Fundamental Analysis Fundamental Analysis
Using all this research data, they then determine the intrinsic value of the company. The value and image of the stock gets affected by fundamental analysis, especially when analysts forecast earnings which are significantly different than the market consensus. The chief assumption on which ‘Fundamental Analysis’ is carried out is that the value of the stock can be determined based on the future earnings of the company. Financial Analysts carry out thorough research on the background and operations of a company, the state of the industry to which the company belongs, the global industry and the global economy etc.

Cash Flow Analysis Cash Flow Analysis
The chief assumption on which ‘Cash Flow Analysis’ is carried out is that the value of a company is the discounted value of the free cash flows to all shareholders and to equity shareholders. Cash flow models are built by investors to predict expected cash flows to the equity shareholders and to the total firm.

Cash Flow Analysis Cash Flow Analysis
The main purpose of ‘Cash Flow Analysis’ is to determine the intrinsic value of a firm. However, it has been found that ‘cash flow’ as an indicator for determining intrinsic value of a firm is not accurate. This is because often the intrinsic value of the firm lies in areas that are difficult to quantify in terms of cash flow. The chief assumption on which ‘Cash Flow Analysis’ is carried out is that the value of a company is the discounted value of the free cash flows to all shareholders and to equity shareholders. Cash flow models are built by investors to predict expected cash flows to the equity shareholders and to the total firm.

Technical Analysis Technical Analysis
The chief assumption on which ‘Technical Analysis’ is carried out is that supply and demand are the key factors needed to understand stock prices and market trends. Therefore, the company’s value is determined in Technical Analysis by focusing on psychological factors such as greed and fear and also economic factors.

Technical Analysis Technical Analysis
A research has found that Technical Analysis is of less value in predicting stock prices. However, several tools used in technical analysis prove to be very useful helpful in managing portfolios. The chief assumption on which ‘Technical Analysis’ is carried out is that supply and demand are the key factors needed to understand stock prices and market trends. Therefore, the company’s value is determined in Technical Analysis by focusing on psychological factors such as greed and fear and also economic factors.

Ratios for Valuing Firms
There are a few key ratios that are used for valuing firms such as follows: Price-to-Earnings Ratio (PE) Price-to-Book Ratio (PB) Return on Equity (ROE) Dividend Payout Ratio Let us look at each in detail.

Price-to-Earnings Ratio (PE)
The ‘Price-to-Earnings Ratio (PE)’ is defined as the market price of the stock divided by the Earnings-per-Share (EPS). This basically means it is what you would pay for $1 of earnings. The PE Ratios is one of the most widely used ratios. It is chiefly used to compare financial performance of different companies.

Price-to-Earnings Ratio (PE)
The ‘Price-to-Earnings Ratio (PE)’ is defined as the market price of the stock divided by the Earnings-per-Share (EPS). This basically means it is what you would pay for $1 of earnings. The PE Ratios is one of the most widely used ratios. It is chiefly used to compare financial performance of different companies. One of the greatest uses of the PE Ratio is for comparing a company’s PE to its own history, the industry PE, or to the market PE. Generally, historical PE is not used by investors. Instead, investors use the firms forecast or PE for the coming year for making investment decisions.

Price-to-Book Ratio (PB)
The ‘Price to Book Ratio (PB)’ is defined as the price of the company’s stock divided by the book value per share. The PB ratio basically indicates the price you are paying for a $1 worth of assets as shown on the balance sheet.

Price-to-Book Ratio (PB)
The ‘Price to Book Ratio (PB)’ is defined as the price of the company’s stock divided by the book value per share. The PB ratio basically indicates the price you are paying for a $1 worth of assets as shown on the balance sheet. Book Value doesn’t look at the value of the assets. It only considers the non-depreciated portion of the assets. Therefore, it is possible that a major discrepancy may exist between the actual value of the assets and their book value

Return on Equity (ROE) Return on Equity (ROE)
The ‘Return on Equity (ROE)’ is defined as a ratio of the company’s Earnings-per-Share (EPS) divided by the company’s book value per share. Thus, ROS measures how well the company is utilizing the assets of the company to make money.

Return on Equity (ROE) Return on Equity (ROE)
The ‘Return on Equity (ROE)’ is defined as a ratio of the company’s Earnings-per-Share (EPS) divided by the company’s book value per share. Thus, ROS measures how well the company is utilizing the assets of the company to make money. So, if a company is utilizing its resources better; then its ROE would be higher. Investors must focus on tracking the trend of the ROE of a company to understand how the company is improving upon the utilization of its resources rather than looking at a single ROE as an absolute number.

Dividend Payout Ratio Dividend Payout Ratio
The ‘Dividend Payout Ratio’ is defined as the ratio of dividends paid divided by the earnings of the company. Also, it is also calculated as dividends per share divided by earnings per share. So, when this ratio is high, it shows that a firm is returning to the shareholders a large percentage of company profits.

Dividend Payout Ratio Dividend Payout Ratio
The ‘Dividend Payout Ratio’ is defined as the ratio of dividends paid divided by the earnings of the company. Also, it is also calculated as dividends per share divided by earnings per share. On the other hand, when this ratio is low, it shows that a firm is retaining most of the profits for internal growth. You can understand that the dividend payout ratio will be different for different types of firms depending upon their internal policies and dividend payout policies.

MCQ Q. Which of the following ratios is often seen as a measure of future earnings potential? Click on the radio button to select the correct answer!

MCQ Good! That's Right! Correct Answer: ‘Price-to-Earnings Ratio (PE)’ is often seen as a measure of future earnings potential. Q. Which of the following ratios is often seen as a measure of future earnings potential? Click here to continue!

‘Price-to-Earnings Ratio (PE)’ is often seen as a measure of future earnings potential. Q. Which of the following ratios is often seen as a measure of future earnings potential? Click here to continue!

Types of Orders As an investor and stock trader, you can place the following three types of orders on your stocks: Limit Order Stop Order Market Order

Types of Orders As an investor and stock trader, you can place the following three types of orders on your stocks: ‘Stop Order’ is an order to buy or sell stock holdings when the market price reaches a certain level. Limit Order ‘Limit Order’ is a request to buy stock at any price up to a specified maximum or to sell stock at any price above a specified minimum. Stop Order Market Order ‘Market Order’ is an offer to buy stock at the market price.

MCQ Q. You have invested in a stock. The stock prices go up and have made a profit for you. Which of the following should you do to help you protect your gains? Click on the radio button to select the correct answer!

MCQ Good! That's Right! Correct Answer: ‘Stop Order’ will help you to sell your stock holdings when the market price reaches certain level and help you protect your gains. Q. You have invested in a stock. The stock prices go up and have made a profit for you. Which of the following should you do to help you protect your gains? Click here to continue!

‘Stop Order’ will help you to sell your stock holdings when the market price reaches certain level and help you protect your gains. Q. You have invested in a stock. The stock prices go up and have made a profit for you. Which of the following should you do to help you protect your gains? Click here to continue!

Electronic Trading Platforms
Types of Brokers There are various types of brokers who offer various kinds of services for buying and selling of stocks and various securities such as follows: Full Service Brokers Discount Brokers Electronic Trading Platforms Let’s look at each in detail.

Full Service Brokers Full Service Brokers Full Service Brokers Discount Electronic Trading Platforms ‘Full Service Brokers’ are the traditional brokers who are present since the start of stock exchanges across the world. Such full service stock brokers develop and maintain personal relationships with clients. Such brokers recommend to their client the purchase and sale of securities based upon the client’s needs.

Full Service Brokers Full Service Brokers Full Service Brokers Discount Electronic Trading Platforms Another important function that such a broker performs is to keep his client informed on stock movement, research stocks and recommend purchases and sales to their customers. The customers are provided with written information by such brokers. Moreover, it is the broker who handles all transactions. Whenever a stock is purchased or sold, the broker is paid a commission on each purchase or sale of stock. A few examples of full service brokers are: Merrill Lynch and Dean Witter. ‘Full Service Brokers’ are the traditional brokers who are present since the start of stock exchanges across the world. Such full service stock brokers develop and maintain personal relationships with clients. Such brokers recommend to their client the purchase and sale of securities based upon the client’s needs.

Discount Brokers Discount Brokers Full Service Brokers Discount Electronic Trading Platforms ‘Discount Brokers’ is a relatively new kind of brokerage service offering that has come up in the brokerage business. The discount brokers through the firm execute a customer’s transaction on behalf of the client. However, a discount broke does not give any advice to the customer regarding the purchase or sale of the security.

Discount Brokers Discount Brokers Full Service Brokers Discount Electronic Trading Platforms It is the customer’s responsibility to research the market, define their own risk parameters and investments and also select the individual securities that have to be traded. Therefore, it is obvious that since all the research is being carried out by the customer himself and the discount broker just carries out the transaction for the customer, the commissions charged by discount brokers are lower than by full service brokers. Discount brokers can provide clients with printed information about various stocks if the customer specifically makes such requests. An example of a discount broker is: Charles Schwab. ‘Discount Brokers’ is a relatively new kind of brokerage service offering that has come up in the brokerage business. The discount brokers through the firm execute a customer’s transaction on behalf of the client. However, a discount broke does not give any advice to the customer regarding the purchase or sale of the security.

Full Service Brokers Discount Electronic Trading Platforms Another more modern and latest form of trading can be done electronically by customers. In such electronic trading, the customers can through the use of computer on-line services initiate their own buy and sell orders.

Full Service Brokers Discount Electronic Trading Platforms Moreover, a broker representative from the portal offering the on-line service confirms each transaction with the customer after the transaction is made. The commissions charged for such online trading service is extremely low. You should bear in mind that in such electronic trading platforms the full responsibility for research falls on the customer. Hence, such online trading should be carried out only by the more sophisticated, experienced and knowledgeable customer. Another more modern and latest form of trading can be done electronically by customers. In such electronic trading, the customers can through the use of computer on-line services initiate their own buy and sell orders.

Criteria for Choosing a Broker
As a new investor, it is important that you should start investing with the help of an experienced broker. Hence, it is very crucial that you should choose the right broker who can guide you to make stock trades in a wise manner.

Criteria for Choosing a Broker
There are a few criteria that you should keep in mind before choosing a broker. So, before you choose a broker, keep in mind the following considerations: The brokerage site should have a useful and informative website and trading platform. The trading platform and interface should be able to allow you to trade during high-traffic trading periods. The account should be properly insured and valid as per local and national regulations. Check and find detailed information about the commission structure. Find out detailed information about all the types of services offered by the brokerage firm. Find out if the brokerage firm offers any daily updates on the stock listings, news, information and dedicated relationship manager as well. Check and find detailed information if the broker or brokerage firm is willing to pay you interest on any un-invested cash in your account. Also, what is the interest rate that the broker is willing to pay?

Common Stock Investing Strategies
You can use a number of different strategies for investing in stocks. The following are a few of the most common strategies for investing in stocks: Buy and Hold Strategy Dollar-cost Averaging Strategy Dividend Reinvestment Strategy Let us look at each in detail.

Hold Buy and Hold Strategy Buy and Hold Strategy
A ‘Buy and Hold Strategy’ is the strategy of buying a financial asset and not selling it for an extended period of time. Hence, this is a long-term strategy. It proves to be very cost-effective.

Hold Hold Buy and Hold Strategy Buy and Hold Strategy
Some of the greatest benefits of this strategy are as follows: This strategy helps investors avoid market timing. It also helps in minimizing the money spent on brokerage fees. It also helps in minimizing taxes. This is because gains are taxed as long-term capital gains. Moreover, as you do not sell for a long-time, you do not pay taxes until you sell. Also, you get stock dividends each year which are taxed at lower tax rates. Buy and Hold Strategy: A ‘Buy and Hold Strategy’ is the strategy of buying a financial asset and not selling it for an extended period of time. Hence, this is a long-term strategy. It proves to be very cost-effective.

Dollar-cost Averaging Strategy
A ‘Dollar-cost Averaging Strategy’ is a strategy of purchasing a fixed dollar amount of a security at regular intervals, such as every month.

Dollar-cost Averaging Strategy
Some of the greatest benefits of this strategy are as follows: This strategy averages out fluctuations in the market and concentrates on the general trend. This strategy helps to avoid taking into account luck and market timing and keep such variables out of the equation. This strategy helps to add discipline to your investing. This is a good investment strategy, when you plan to fund your investments from a small portion taken out of your salary each month. Dollar-cost Averaging Strategy: A ‘Dollar-cost Averaging Strategy’ is a strategy of purchasing a fixed dollar amount of a security at regular intervals, such as every month.

Dividend Reinvestment Strategy
A ‘Dividend Reinvestment Strategy’ is a strategy where additional shares of stock are purchased with the dividend payments. ‘Dividend Reinvestment Strategy’ is also known as ‘Dividend Reinvestment Plans’ or ‘DRIPs’.

Dividend Reinvestment Strategy
Some of the greatest benefits of this strategy are as follows: This strategy greatly simplifies the investment process. It helps you to avoid paying brokerage fees. This strategy helps to minimize the taxes that you pay. This is because you will pay taxes each year on the stock dividends. However, the tax rate is lower on stock dividends than your marginal tax rate. Dividend Reinvestment Strategy: A ‘Dividend Reinvestment Strategy’ is a strategy where additional shares of stock are purchased with the dividend payments. ‘Dividend Reinvestment Strategy’ is also known as ‘Dividend Reinvestment Plans’ or ‘DRIPs’.

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Introduction to Stocks and Investing

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