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Stocks. Chapter 9. Section 9.1 – Common and Preferred Stocks. Explain reasons for investing in common stock Explain reasons for investing in preferred stock. Common Stock. Why do companies sell stock? Make new products Sell products Fund its operations Expand

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Chapter 9

Section 9 1 common and preferred stocks

Section 9.1 – Common and Preferred Stocks

  • Explain reasons for investing in common stock

  • Explain reasons for investing in preferred stock

Common stock

Common Stock

  • Why do companies sell stock?

    • Make new products

    • Sell products

    • Fund its operations

    • Expand

  • Why do people buy stocks?

    • To make money

    • More money than conservative investments

Why corporations issue common stock

Why Corporations Issue Common Stock

  • Private corporations

    • Issue to small amount of people

    • Are not traded openly in stock markets

  • Public corporations

    • Anyone can buy/sell openly in stock markets

  • Form of equity – money that doesn’t have to be repaid

    • Demand for stock affected by

      • Expected sales revenue

      • Earnings

      • Expansions or mergers

  • Dividends not mandatory, may be reinvested back into business

Why investors purchase common stock

Why Investors PurchaseCommon Stock

  • Income from dividends

    • Board of directors often votes to pay dividends to keep stockholders happy

  • Appreciation of stock value

    • Can sell at a higher price for profit

  • Increased value from stock splits

    • Decreased price attracts more investors, then price starts to rise again

  • Voting rights and control of the company

Preferred stock

Preferred Stock

  • What is preferred stock?

    • Mix between regular common stock and a bond

    • Each share of preferred stock is normally paid a relatively high dividend and has first dibs over common stock at the company's assets in the event of bankruptcy

    • Stockholders know exactly what they will receive from par value on stick certificate

    • In exchange for the higher income and safety, preferred shareholders miss out on large potential capital gains [or losses]

    • Owners of preferred stock generally do not have voting privileges

  • Why do corporations issue preferred stock?

    • Attract those conservative investors who do not want to purchase common stock

  • Why do investors purchase preferred stock?

    • Safe and steady source of income, lower return than corporate bonds but better than common stock

Types of preferred stock

Types of Preferred Stock

  • Cumulative Preferred Stock

    • Pays dividends “saved” up, even if company omits some payments to other preferred stock holders

  • Convertible Preferred Stock

    • Can be exchanged for a specific number of common stock – spreads risk and return

  • Participation Feature

    • Rare feature that allows retained earnings to go back to these stockholders after dividends are paid to be

Tracking your stock investments

Tracking Your Stock Investments

  • Monitor

    • Graph $ value on daily or weekly basis

  • Watch the financials

    • Evaluate current sales, profits, and projected

  • Track the products

    • Poor-quality or lack of new up-to-date can affect value of stock

  • Watch the economy

    • Inflation rate, overall economy

  • Be patient

    • Wait it out if the company is good

Section 9 2 evaluating stocks

Section 9.2 – Evaluating Stocks

  • Types of stock investments

  • Sources of information to evaluate stock investments

  • Factors that affect stock prices

How are stocks classified

How are stocks classified?

  • Blue-chip stocks

  • Income stocks

  • Growth stocks

  • Cyclical stocks

  • Defensive stocks

  • Large and small cap stocks

  • Penny Stocks

Blue chip stocks

Blue Chip Stocks

  • Safe investment, attracts conservative investors

  • Issued by strongest, most respected companies

  • At & T, General Electric, Kellogg

Income stocks

Income Stocks

  • Pays higher-than-average dividends

  • Dividends are predictable, often choice of retired people

  • Bristol-Myers Squibb, Dow Chemical

Growth stocks

Growth Stocks

  • Issued by a corporation whose potential earnings may be higher than average earnings predicted for all the corporations in the country

  • Do not pay dividends, but buy for potential increase in value (long-term investment)

  • Indicators: building new facilities, introducing new, high-quality products, or conducting recognized research and development

  • Home Depot, Southwest Airlines

Cyclical stocks

Cyclical Stocks

  • Do well when economy is good, but poorly during recessions

  • Ford and Centrex

  • Airlines, manufacturing, industries based on travel

Defensive stocks

Defensive Stocks

  • Not subject to ups and downs of business cycle

  • Many blue-chip stocks, income stocks, and Procter & Gamble

  • Utilities, drug companies, food and health care

Large cap and small cap stocks

Large-Cap and Small-Cap Stocks

  • Large-cap comes from company that issued a large number of shares of stock

  • Small-cap comes from company with less than $500,000 capitalization

  • Capitalization – total amount of stocks and bonds issued by company

  • Large-cap is conservative and secure and small-cap is a higher risk

Penny stocks

Penny Stocks

  • Cheap (less than $1 per share typically), but highly speculative

  • Those of “hot” new product

    • Beanie Babies, Rubic’s Cube, Cabbage Patch Kids, Furby’s

What s the problem with these stocks

What's the Problem with These Stocks?

  • What makes penny stocks risky? Four major issues arise when you decide to buy these securities:

    • Lack of Information Available to the Public

    • No Minimum Standards

    • Lack of History

    • Liquidity

What company is this

What company is this?

  • After just a few years in the public markets, it began paying a dividend and never stopped -- amazing for such a tiny company.

  • Related to that point, its dividend started in the teeth of a bear market in the early 1970s -- a telling sign of the strength of its financials, given the trying times.

  • Wall Street treated the company like it was a bunch of hillbillies in Arkansas. For years, no analysts followed it.

  • Institutional ownership was well below 50% for years and years. As we said, hardly anyone cared.

  • Sam Walton owned the majority of the stock. Here was a founder with a stake in the organization's enduring success.

  • Its concept was new and innovative, yet proven. This store had been in business for eight years before going public, with more than 30 stores and more than $32 million in sales on the day of its IPO.

What is pump and dump

What is Pump and Dump?

  • Ever received one of those emails that pretends to be TO someone else, passing on some hot stock tip they've learned? Referred to as 'pump and dump' scams, the intent of the email is to get lots of people to take advantage of this unexpected windfall of information and buy the stock. This inflates the price, at which time the scammers sell their shares for a hefty profit. It works like this:

  • Scammers buy worthless stock at a very low price

  • Fake email is sent to millions of people, claiming the stock is projected to move

  • People buy into the scam, and thus buy the stock, thereby raising the price

  • The scammers sell off their holdings for a hefty profit

  • The victims are left holding worthless stock

Poop and scoop

Poop and Scoop

  • Here the manipulators spread highly negative false rumors about a company in order to drive the price down

  • They buy as the stock plummets, counting on a rebound in price once the rumor is dispelled. In a related fraud, manipulators first short sell stock before releasing the rumors. On the subsequent decline, they cover their positions at a profit.

Front running

Front Running

  • In this case, the news is actually true; insiders or brokers, knowing what is coming, take large positions ahead of the news becoming public.

  • If insiders are involved, this is also referred to as insider trading

Circular trading

Circular Trading

  • Happens when a stock has been laying dormant for a long time

  • Using multiple accounts, often established overseas, they will trade the same shares back and forth between their own accounts to create the appearance of activity

  • Once third party interest is generated, one of the schemes described above may be executed.

How do you assess a stock investment

How Do You Assess a Stock Investment?

  • Newspapers

  • The Internet

  • Stock Advisory Sources

  • Corporate New Publications



  • Most major newspapers have financial sections

  • May cover stocks of local interest

  • Detailed stock information


  • Most corporations have their own Web sites

  • More up-to-date and detailed than printed publications

Stock advisory services

Stock Advisory Services

  • Charge fees

  • Information varies from simple alphabetic listings to detailed financial reports

Corporate News Publications

  • Annual and quarterly reports have activities and detailed financial info.

  • Call, write, or email

Factors that influence the price of stock

Factors that Influence the Price of Stock

  • Bull Market – Occurs when investors are optimistic about economy and buy stocks

  • Bear Market – Occurs when investors are pessimistic about the economy and sell stocks

  • Company’s profits, losses, and numerical measures of its financial situation

Numerical measures for a corporation

Numerical Measures for a Corporation

  • Current Yield

  • Total Return

  • Earnings Per Share

  • Price-Earnings Ratio

Current yield

Current Yield

  • Synopsis: Computing the current yield of your stocks will help you to determine the value of your investment

  • Example: Suppose that Tanika purchases stock in Assume that pays an annual dividend of $1.20 and is currently selling for $24 a share. What is Tanika’s current yield?

  • Formula: Annual Dividend = Current Yield

    Current Market Value

  • Solution: $1.20 = 0.05 = 5% or .05


Total return

Total Return

  • Synopsis: Calculating the total return of your investment will let you know whether your investment is increasing or decreasing in value

  • Example: Two years ago Mark bought 40 shares of Ferguson’s Motor Company for $70 a share. The stock pays an annual dividend of $1.50. Mark is going to sell his stock at the current price of $120 a share. What would be the total return on his investment?

  • Formula: Current Return + Capital Gain = Total Return

    Current Return = Dividend * Number of Shares * Years Held

    Capital Gain = (Selling Price per Share - Purchase Price per

    share) * Number of Shares Held


Current Return + Capital Gain = Total Return

Current Return = Dividend * Number of Shares * Years Held

Capital Gain = (Selling Price per Share - Purchase Price per

share) * Number of Shares Held

Current Return $1.50 * 40 * 2 + $120

Capital Gain ($120 - $70) * 40 = $2000

Total Return $120 + $2000 = $2,120

Earnings per share

Earnings Per Share

  • Synopsis: Figuring out the earnings per share can help you find out a company's profits. This information can help you determine the general health of the company in which you are investing.

  • Example: EFG Corporation had net earnings of $800,000 last year. EFG had 100,000 outstanding shares of common stock. What were EFG’s earnings per share?

  • Formula: Net Earnings = Earnings Per Share

    Common Stock Outstanding

  • Solution: $800,000 = $8


Price earnings ratio

Price-Earnings Ratio

  • Synopsis: The price-earnings ratio is the most common measure of how expensive a stock is. Determining the price-earnings ratio can help you decide whether a stock is worth purchasing.

  • Example: EFG’s stock is selling for $96 a share. EFG’s earnings per share are $8. What is EFG’s price-earnings ratio?

  • Formula: Market Price Per Share = Price-Earnings Ratio

    Earnings Per Share

  • Solution: $96 = 12


Investment theories

Investment Theories

  • Theories on how to evaluate possible investments

    • Fundamental Theory

    • Technical Theory

    • Efficient Market Theory

Fundamental theory

Fundamental Theory

  • Assumes a stock’s real value is determined by looking at company's future earnings

  • Look at financial strength, type of industry, new products, state of economy

Technical theory

Technical Theory

  • Based on idea that a stock’s value is determined by stock market forces

  • Look at # of stocks bought or sold over time

  • Look at total number of shared traded

Efficient market theory

Efficient Market Theory

  • Believe stock price movements are purely random

  • All investors have considered all available information on a stock, therefore it is impossible to outperform the market over a long period of time

  • Any time you buy and sell securities, you're engaging in a game of chance, not skill. If markets are efficient and current, it means that prices always reflect all information, so there's no way you'll ever be able to buy a stock at a bargain price.

Section 9 3 buying and selling stocks

Section 9.3 – Buying and Selling Stocks

  • How to describe how stock are bought and sold

  • How to explain how the trading strategies used by long-term investors and short-term investors

Markets for stocks

Markets for Stocks

  • The Primary Markets

  • The Secondary Markets

Primary markets

Primary Markets

  • Investors purchase new securities from a corporation

    • May buy through investment bank

    • May buy from representative of corporation

  • Initial Public Offering

    • When corporations sell to public for very first time

    • Use for new business start ups or business growth and expansion

    • Considered high-risk investment

Secondary markets

Secondary Markets

  • Market for existing securities being currently traded

  • Securities exchange

    • Marketplace where brokers who represent investors meet to buy and sell securities

    • NYSE is one of largest in world

  • Over-the-counter market – network of dealers who buy and sell the stocks of corporations that are not listed on a securities exchange

  • Most traded through NASDAQ



  • Video

How to buy and sell stock

How to Buy and Sell Stock

  • Brokerage Firms

  • Account Executives

  • Types of Orders

  • Computerized Transactions

Brokerage firms

Brokerage Firms

  • Full service, discount, online

  • Difference is in commission cost and service done

  • Full service charge highest for personalized service and free research

  • Discount and online have printed material or info on website to help you

Account executives brokers

Account Executives/Brokers

  • Licensed, buy and sell securities for clients

  • Handle your portfolio, but be sure to describe your short, long-term goals

  • Stay involved, firms not responsible for financial losses

  • Be careful of churning, a lot of buying/selling to make more commissions for broker

  • $25 to $55 for buying and selling stocks, additional based on # of shares and value

Types of orders

Types of Orders

  • Order to buy/sell – done over phone, Internet, or in person

  • Market Orders

  • Limit Orders

  • Stop Orders

Market orders

Market Orders

  • Request to buy/sell at current market value

  • Brokers/rep tries to get best price possible, like an auction

  • Payment for stocks required with 3 weeks

  • Stock certificate arrive in 4 to 6 weeks

Limit orders

Limit Orders

  • Request to buy/sell at a specific price

  • No guarantee of purchase or sale

  • Limit orders filled in order received, so your turn may come after price has risen

Stop orders

Stop Orders

  • Used for selling a stock at next avail. opportunity when price reaches a specified amount

  • You enter a stop loss order at a point below the current market price. If the stock falls to this price point, the stop loss order becomes a market order and your broker sells the stock. If the stock stays level or rises, the stop loss order does nothing.

  • Stop loss orders are cheap insurance that protects you from a loss.

Computerized transactions

Computerized Transactions

  • Full and discount brokerage firms allow investors to trade online

  • Software packages or broker's sites can be used to evaluate stock, track and monitor portfolio, buy and sell securities

Short skirts and stocks

Short Skirts and Stocks

  • Video

Investment strategies

Investment Strategies

  • Long-term techniques

    • Buy and Hold

    • Dollar Cost Averaging

    • Direct investment and dividend reinvestment

  • Short-term techniques

    • Buying on margin

    • Selling short

Buy and hold

Buy and Hold

  • Buy and hold for ten years or more

  • You may get:

    • Dividends

    • Price per stock may go up

    • Stock may split

Dollar cost averaging

Dollar Cost Averaging

  • Systematic purchase at regular intervals

  • Avoid having to buy high and sell low

  • Simple and practical for those with steady incomes

Direct investment and dividend reinvestment

Direct Investment and Dividend Reinvestment

  • Direct investment

    • Investors buy stock directly from company

    • Save brokerage fees and commission

  • Dividend reinvestment

    • Automatically reinvests any dividends you earn back into more stock

Buying on margin

Buying on Margin

  • Borrow money from broker to buy stock by opening a margin account and sign a contract

  • Must deposit a minimum of $2000 in cash or eligible securities with broker (collateral)

  • Buy stock using money from margin acct. and borrowing money from broker

    • Result – you get more stocks with less of your own cash

    • Stock price goes up, you sell, pay back broker

Selling short

Selling Short

  • Arrange to borrow # of shares of stock from brokerage firm

  • Sell borrowed stock, assuming value will drop within a short period of time

  • Buy stock at a lower price than the price you sold it for

  • Use new stock to replace original stock that you borrowed

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