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Investing 101 Kentucky Council on Economic Education 08/22/06
Power of Compounding • Interest on principal plus interest earned • Rule of 72 Penny a day…or $1million? • The power of compounding was said to be deemed the eighth wonder of the world - or so the story goes - by Albert Einstein.
Stocks • A share in the ownership of a company.100,000 shares outstanding in companyYou own 1,000 shares (100,000/1000) = 1% ownership. • Types of Stock • Common Stock • Entitles the holder to one vote in the affairs of the company and one vote to elect the board members. • Preferred Stock • Usually doesn't come with the same voting rights as common stockholders. • Receive a share of profits before common stockholders. • In the event of company dissolution, preferred shareholders have a prior claim to assets ahead of common shareholders, but behind creditors.
Stock Classifications • Blue-Chip Stocks biggest companies in the country • Growth Stocks A growth company usually spends a lot of money on research and puts all its profits back into the company instead of paying dividends • Income Stocks stable companies that pay higher-than-average dividend • Cyclical Stocks move up or down in sync with the business cycle, i.e., automobile, housing, etc. • Defensive Stocks unaffected by changes in the business cycle,i.e., food, utilities. Etc. • Value Stocks considered undervalued by investors • Penny Stocks - low-priced, speculative stocks
Industries and Sectors • Industries - Companies are grouped by industry, based on the products or services they offer. Companies in the airline industry would be Delta, TWA, Southwest, etc. • Sectorsare broad groupings of similar industries. The airlines industry would be part of the transportation sector. • Industries/sectors are used by investors to compare similar companies
Dividends • Offered by well established companies • Paid to investors • As cash or stock (usually quarterly) • Decided by the Board of Directors • Record Date/Distribution Date
Stock Splits • 2 for 1, 3 for 1 • Reverse splits, i.e., 1 for 2 • Example: • Johnny holds 100 shares of GTD, currently valued at $60/share, so he has a $6,000 investment. • GTD announces a stock split of 2 for 1. • After the stock split, Johnny will hold 200 shares of stock, and those 200 shares will be valued at $30/share. 200 shares X $30 share = $6,000. (Same value!)
IPO – Initial Public Offerings • First sale of stock by a company to the public. • Distributed through investment bankers in the "primary market” • Buyers (usually institutional investors) of these new shares of stock will sell to the public
Mutual Funds • Mutual fund company • Manager • Pooled money of investors • Investors buy shares of the mutual fund • Good way to get started in investing • In the Stock Market Game simulation, students can buy mutual funds in addition to stocks.
Bonds • IOU issued (debt securities) • Issued by governments and corporations to raise money • Investor is the lender • Company/Govt repays principal plus interest (generally quarterly) • Students cannot invest in bonds in the Stock Market Game.
Forms of Business • Sole proprietorship • Partnership • Corporation
Public or Private Company? • Private company does not issue stock to the public, only privately. • Public company is a corporation that has "gone public“.
How do businesses raise capital? • Three major sources of financial capital for companies • Retained earnings • Debt (loans, corporate bonds, etc.) • Equity (stock)
Parent Companies, Brands, Subsidiaries • Parent Company - A company that exercises control over one or more subsidiary enterprises. • Subsidiary - a wholly or partially owned company which is part of a large corporation (parent). • Brand - A name, term, symbol, design, or combination of these that identifies a seller's products and differentiates them from competitors' products, i.e., Taco Bell, Lands’ End, etc.
Mergers and Acquisitions • A merger is a form of corporate acquisition in which one firm absorbs another and the assets and liabilities of the two firms are combined. • An acquisition is when one business takes possession of another business. This is also called a takeover or buyout. • Mergers are a way for a company to grow faster, to become more efficient, to acquire new product lines, to change its image, or to eliminate a rival. • In many corporate mergers or acquisitions, the shares of one company are converted to shares of the other company. In other cases, one company simply buys all of the other company's shares. It pays cash for these shares.
Market Exchanges • New York Stock Exchange NYSE • Oldest stock market in US • Auction market (with brokers on trading floor) • American Stock Exchange (AMEX) • NASDAQ(National Association of Securities Dealers Automated Quotation System), is an electronic market • Over the Counter Bulletin Board (OTBB)for companies that don't qualify to list on the major market exchanges because they are too small or their stock prices too low.
History of Stock Market • May 17, 1792 • Buttonwood Tree Agreement • NYSE – 1817 • Curb trading – AMEX • Securities Exchange Act of 1937
Stock Market Crash • October 29, 1929 - Black Tuesday • Set off the Great Depression • NPR Audio http://www.npr.org/templates/story/story.php?storyId=4134779
Indices • A stock index is a measure of average stock prices in a group of individual stocks. • Reflect how the market is doing as a group • Examples: • Dow Jones Industrials - which tracks 30 blue chip stocks (of well-known companies) • Standard & Poor's 500- which tracks 500 stocks from industrial, transportation, utility and financial companies • Russell 2000- which tracks 2000 smaller company stocks • NASDAQ Composite Index - which tracks all the stocks listed on the NASDAQ, almost 4,000 in all.
The DOW • Dow Jones Industrial Average • 30 blue chip stocks • A stock market index • Most-quoted market indicator
Bull and Bear • Bear market describes a period of time when stock prices are falling. • Bull market is a period when stock prices are generally rising.
Factors Affecting the Stock Market • Health • company • industry • economy • Global • Good News/Bad News • Microeconomic variables - factors that can affect companies or industries • Macroeconomic variables - factors that affect the economy • Consumer confidence • Investor perception
Diversification "Don't put all your eggs in one basket." • Strategy of spreading your investment dollars across various types of securities, i.e., • several industry sectors (e.g., transportation, technology, airlines, retail, etc.) • large and small companies, • growth and income stocks, • cyclical and non-cyclical stocks, • blue chip companies, and • international companies. • In the Stock Market Game, • 5 stock minimum rule • 30% maximum equity
Supply and Demand • Stock prices change because of supply and demand • more buyers than sellers – price goes up! • More sellers than buyers – price goes down!
Reading an Annual Report Get from company website or call/write company • Chairman of the Board Letter • Sales and Marketing • 10 Year Summary of Financial Figures • Management Discussion and Analysis CPA Opinion Letter • Financial Statements • Subsidiaries, Brands and Addresses • List of Directors and Officers • Stock Price History from Annual Report Library (http://www.zpub.com/sf/arl/)
Fundamental Analysis Thorough review of company • Product • Operating efficiency • Management • Financial performance • Profit/Loss, EPS, P/E, etc. • Position in Industry
Technical Analysis • Used to evaluate the worth of a stock by studying market statistics. • Stock and stock market trends • Charting
Crunching the Numbers • Book value - This represents the different between the company's assets and liabilities. A low book value (from too much debt) could mean that the company's profits will be limited. However, a low value may also indicate that the assets are underestimated, and that the stock is a good value for potential investors. • Earnings Per Share (EPS) - This represents the company's net profit divided by the number of shares outstanding. Analysts typically look for steadily increasing EPS, which shows a pattern of consistent growth.
Crunching the Numbers • Price/Earnings (P/E) Ratio - company's stock price divided by its 12 month EPS. • High P/E means high projected earning • If a company has a PE of 10, that means that investors are willing to pay $10 for every $1 of last year's companies earnings. • Compare the PE ratios of other companies in the same industry, or to the market in general, or against the company's own historical P/E ratio. • Beta – quantifies how volatile a stock is compared to the overall market • A stock that rises or falls in value at the same rate as the market has a beta of 1.0. • Beta below 1 - less volatile -- and potentially less risky • Beta above 1 - more volatile, meaning that investors might expect its price to rise or fall more quickly.
Margin • Going on Margin" borrowing money to invest • In SMG – pay 7% interest (per annum) for any money spent over initial $100,000 cash. • Very Risky – not suitable for a long-term, buy-and-hold investor. • Minimum Maintenance If the Total Equity in your portfolio falls below 30% of the value of your long and short positions, your team will receive a margin call. (Note: In a margin call, the computer will automatically sell shares of stock in the portfolio to recoup its losses.)
Short Selling • Way to make money in the stock market--particularly during a Bear market when prices are dropping. It can also be effective if you know a company is headed in a downward spiral. • Brokerage loans you stock from inventory • You sell the stock you “borrowed” • When stock value drops, you “short cover” – buy the stock on the market • You give brokerage back their stock you borrowed, and • You profit from the difference Short Sell 100 shares @ $50.00 (you borrow 100 shares of stock and sell it at $50/share and get credited with $5,000) Short Cover 100 shares @ $30.00 (you buy the stock at $30/share and your account is charged $3,000 You return this stock to the broker Your profit is $2,000. • You can lose more than you put in! • Students can short sell in the Stock Market Game.
Investing for the Long Term 1) start with a plan 2) understand your risk tolerance 3) diversify 4) keep track of your investments 5) invest for the long term