Stocks

1. Stocks Chapter 9

2. Common and Preferred Stock 9.1 • Objectives • How to identify the reasons for investing in common stock • How to identify the reasons for investing in preferred stock

3. Common and Preferred Stock 9.1 • Why it’s important • Recognizing the reasons for investing in common and preferred stock will enable you to make the best investments for your financial situation

4. Common and Preferred Stock 9.1 • Securities are all of the investments, including stocks, bonds, mutual funds, options, and commodities, that are traded—bought and sold—on securities exchanges or the over-the-counter market.

5. Common and Preferred Stock 9.1 • Common Stock – (from chapter 8) is stock that provides the most basic form of corporate ownership • The company uses the money made by selling stock to make and sell its product, fund its operations, and expand • If they company earns a profit, the stockholders earn a return, or gain on their investment

6. Common and Preferred Stock 9.1 • People buy and sell stocks for one reason: they want larger returns than they can get from more conservative investments (like savings accounts or government bonds)

7. Common and Preferred Stock 9.1 • Why Corporations Issue Common Stock? • To raise money to start up their business and then to help pay for its ongoing activities • Private corporations (closely held corporations) – shares are owned by a relatively small group of people and are not traded openly in stock markets • Public corporations (publicly held) – sells its shares openly in stock markets where anyone can buy them

8. Common and Preferred Stock 9.1 • Why Corporations Issue Common Stock? • A Form of Equity – corporations do not have to repay the money a stockholder pays for stock • A stockholder can sell it to another investor • The price is set according to how much the buyer is willing to pay • Dividends Not Mandatory – corporate board of directors decide whether any profits will be paid to stockholders

9. Common and Preferred Stock 9.1 • Why Corporations Issue Common Stock? • Voting Rights and Control of the Company • In return for your money, management gives you certain rights as a stockholder (example, by law the corporation holds a meeting every year where stockholders vote on company business) • Stockholders usually get one vote for each share they own • Can vote in person or by proxy (a document that transfers a stockholder’s voting rights to someone else)

10. Common and Preferred Stock 9.1 • Why Corporations Issue Common Stock? • Voting Rights and Control of the Company • Some state require that corporations offer existing stockholders a preemptive right (give the current stockholders the right to buy any new stock the corporation issues before the stock is offered to the general public)

11. Common and Preferred Stock 9.1 • Why Investors Purchase Common Stock – • Income From Dividends – to keep stockholders happy, most board members vote to pay dividends as long as the company is able • Most dividends are paid quarterly (every three months) and sometimes a special cash dividend if the company has a large increase • Dollar Appreciation (increase) of Stock Value – have to decide whether to sell or keep the stock if the value goes up • If you sell the difference between the price that you paid for it and the price at which you sell it is your profit

12. Common and Preferred Stock 9.1 • Why Investors Purchase Common Stock – • Possibility of Increased Value from Stock Splits • Value can increase through a stock split (a process in which the shares of stock owned by existing stock holders are divided into a larger number of stocks) • Example: If you had 10,000 shares at $50 a share and they split you would then have 20,000 shares at $25 a share. • Why? Sometimes management believes that the stock should be trading at an ideal price range and if the market value is a lot higher, a stock split will bring it back in line

13. Common and Preferred Stock 9.1 • Why Investors Purchase Common Stock – • Possibility of Increased Value from Stock Splits • Why? Sometimes management believes that the stock should be trading at an ideal price range and if the market value is a lot higher, a stock split will bring it back in line • It makes the shares more attractive to investors and the price starts to rise • But the value is NOT guaranteed to go up after a split

14. Common and Preferred Stock 9.1 • Preferred Stock – gives the owner the advantage of receiving cash dividends before common stockholders • You know the actual dollar amount of the dividend you will receive before you buy • It is either a specific amount of money or a percentage of the par value of the stock • Par value - an assigned dollar value, often random, that is printed on a stock certificate for example if a par value of a stock is $30 and the dividend rate is 5%, the dollar amount of the dividend is $1.50 ($30x5%=$1.50)

15. Common and Preferred Stock 9.1 • Why Corporations Issue Preferred Stock • As a way to raise money (used less often than common stock and only by a few corporations) • Might be attractive to conservative investors who don’t want to buy common stock • Preferred stockholders also have limited voting rights if the company is in financial trouble

16. Common and Preferred Stock 9.1 • Why Investors Purchase Preferred Stock? • It’s considered the “middle investment” because its safer than common stock, but not as safe as bonds

17. Common and Preferred Stock 9.1 • Why Investors Purchase Preferred Stock? • People who want a steady source of income often buy preferred stock but it lacks growth potential that common stock offers • So…Preferred stocks are not considered a good investment for most people

18. Common and Preferred Stock 9.1 • Why Investors Purchase Preferred Stock? • To make preferred stock more attractive to investors some corporations may offer: • Cumulative preferred stock – stock whose unpaid dividends build up and must be paid before any cash dividend is paid to common stockholders • For example: if a corporation decides to omit one or more dividend payments to preferred stockholders, then people who have cumulative preferred stock will still receive those dividend payments during a later payment period

19. Common and Preferred Stock 9.1 • Why Investors Purchase Preferred Stock? • To make preferred stock more attractive to investors some corporations may offer: • Convertible Preferred Stock - stock that can be exchanged for a specified number of shares of common stock • Participation Feature – allows preferred stockholders to share in the corporation’s earnings with the common stockholders • After a required dividend is paid to preferred stockholders and a stated dividend is paid to common stockholders, the remainder of the available earnings is shared…very rare feature

20. Stocks Chapter 9 Section 9.2 – Evaluation of a Stock Issue

21. Types of Stock Investments • Stocks are classified into the following categories: • Blue-Chip Stock • Income Stock • Growth Stock • Cyclical Stock • Defensive Stock • Large Cap Stock and Small Cap Stock • Penny Stocks

22. Types of Stock Investments • Blue Chip Stocks – considered a safe investment that generally attracts conservative investors • Issued by the strongest and most respected companies • AT&T, General Electric, and Kellogg • Look for leadership in an industry, a history of stable earnings, and consistency in the payment of dividends

23. Types of Stock Investments • Income stock – pays higher than average dividends compared to other stock issues • People who buy preferred stock are also attracted to this type of stock • Examples: Bristol-Myers Squibb and Dow Chemical and gas and electric companies

24. Types of Stock Investments • Growth stock – issued by a corporation whose potential earnings may be higher than the average earnings predicted for all the firms in the country • Generally don’t pay dividends • Look for signs that the company is engaged in activities that produce higher earnings and revenues: • Building new facilities; introducing new, high quality products; or conducting recognized research and development • In the early 2000s included Home Depot and Southwest Airlines

25. Types of Stock Investments • Cyclical stock – has a market value that tends to reflect the state of the economy • When the economy is improving the market value of cyclical stock usually goes up and if the economy is declining then it tends to go down • Why? Because the companies are linked directly with activities of a strong economy. • Investors buy when right before the economy improves and sell right before the economy starts to decline • Ford and Centex are considered cyclical stocks

26. Types of Stock Investments • Defensive stock – a stock that remains stable during declines in the economy • Companies that issue defensive stocks have steady earnings and can continue to pay dividends • Many blue chip stocks and income stocks may also be considered defensive stocks • Proctor & Gamble and Kellogg

27. Types of Stock Investments • Large cap and small cap stocks – • Large cap stock – the stock of a corporation that has issued a large number of shares of stock and has a large amount of capitalization (the total amount of stocks and bonds issued by a corporation) • Stocks listed in the Dow Jones averages are typically large cap stocks • These stocks appeal to conservative investors because they are considered secure

28. Types of Stock Investments • Large cap and small cap stocks – • Small cap stocks – issued by a company with a capitalization of $150 million or less • Considered higher investment risk because smaller, less established companies issue this type of stock

29. Types of Stock Investments • Penny stock – typically sells for less than $1 a share, although it can sell for as much as $10 a share • Issued by new companies or companies whose sales are very unsteady • Prices of penny stocks can go up and down wildly • Hard to keep up with performance because the information is hard to find • Very risky and should be purchased only by investors who understand all the risks

30. Sources for Evaluating Stocks Financial section of newspapers Internet Stock Advisory Services Corporate News Publications

31. Factors that Influence the Price of Stock • When you are deciding whether to buy or sell stock you must first consider the overall condition of the stock market: • Bull market – a market condition that occurs when investors are optimistic about the economy and buy stocks • Bear market – a market condition that occurs when investors are pessimistic about the economy and sell stocks

32. Factors that Influence the Price of Stock • Numerical Measures for a Corporation • One of the most common calculations investors use to track the value of their investments is the current yield (the annual dividend divided by the investment’s current market value) • Generally, an increase in current yield is a healthy sign for any investment

33. Factors that Influence the Price of Stock • Numerical Measures for a Corporation continued • Also need to know whether your investment is increasing or decreasing in dollar value…Totalreturn is a calculation that includes the annual dividend as well as any increase or decrease in the original purchase price of the investment • Total Return = Current Return + Capital Gain • Current Return = Dividend x Number of Shares x Years held • Capital Gain = (Selling Price Per Share – Purchase Price Per Share) x Number of Shares held

34. Factors that Influence the Price of Stock • Numerical Measures for a Corporation continued • Earnings per share are a corporation’s net, or after tax earnings divided by the number of outstanding shares of common stock. This measures the amount of corporate profit that can be assigned to each share of common stock. • Gives a stockholder an idea of how profitable the company is…an increase in earnings per share is a good sign for any investment.

35. Factors that Influence the Price of Stock • Numerical Measures for a Corporation continued • Price-earnings (PE) ratio – the price of one share of stock divided by the corporation’s earnings per share of stock outstanding over the last 12 months • Used to compare corporate earnings to the market price of a corporation’s stock • Key factor that serious investors as well as beginners can use to decide to invest in stock • A low PE ratio indicates that a stock may be a good investment; the company has a lot of earnings compared to the price of the stock • A high PE ratio indicates that a stock may not be a good investment; the company has little earnings compared to the price of the stock • Although PE ratios vary by industry, they range between 5 and 35 for most corporations

36. Investment Theories Fundamental theory – assumes that a stock’s real value is determined by looking at the company’s future earnings Technical theory – based on the idea that a stock’s value is really determined by forces in the stock market itself Efficient market theory – stock price movements are purely random

37. Stocks Chapter 9 Section 9.3 – Buying and Selling Stock

38. Objectives • How to describe how stocks are bought and sold • How to explain the trading techniques used by long-term investors and short-term speculators

39. Why It’s Important • You can cut costs by buying and selling stocks efficiently. Using various strategies for investing can increase your total return on investments

40. Buying and Selling Stock • To buy common or preferred stock, you usually have to go through a brokerage firm and the brokerage firm must buy the stock in the primary or secondary market.

41. Primary Markets for Stocks • Primary market – market in which an investor purchases securities from a corporation through an investment bank or some other representative of the corporation • An investment bank is a financial firm that helps corporations raise funds, typically by selling new securities • An initial public offering (IPO) occurs when a company sells stock to the general public for the first time • To fund new business start-ups or to finance new corporate growth and expansion

42. Secondary Markets for Stock • After stocks are sold on the primary market, they are sold in the secondary market. The secondary market is a market for existing financial securities that are currently traded among investors. • Secondary Markets include • Securities Exchanges • Over-the-Counter Market • Account Executives • Brokerage Firms

43. Secondary Markets for Stock • Securities Exchanges - marketplace where brokers who represent investors meet to buy and sell securities. These include the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX). • First have to be registered with the exchange on which they will be traded • NYSE is one of the largest • Must have a very large capitalization and trade many shares

44. Secondary Markets for Stock • Over-the-counter (OTC) market— a network of dealers who buy and sell the stocks of corporations that are not listed on a securities exchange. Most OTC stocks are traded through NASDAQ. • Electronic marketplace • Many forward-looking companies trade on NASDAQ, many are fairly small, but some very large companies are also traded on NASDAQ • Microsoft, Intel, and MCI

45. Secondary Markets for Stock • Account executives—or stockbrokers, are licensed individuals who buy or sell securities for clients • Deals with all types of securities and can handle your entire portfolio (consists of all the securities held by an investor) • Stay actively involved in decisions about your investments; never let a stockbroker take action on your accoutn without your permission • Be aware of churning – when an account executive does a lot of buying and selling of stocks within your portfolio to generate more commissions (a fee charged by a brokerage firm for buying/selling of securities)

46. Secondary Markets for Stock • Brokerage Firms - can be either full-service, discount, or online, depending on services provided and fees charged. The biggest difference is the amount of commission you will be charged when you buy or sell securities.

47. Secondary Markets for Stock • Most investors trade stock either over the telephone or on the Internet • You can also go to a brokerage firm to place your order • Market order – a request to buy or sell a stock at the current market value; the account representative will try to get the best price possible and make the transaction as soon as possible

48. Secondary Markets for Stock • Limit order – a request to buy or sell a stock at a specified price; you will agree to sell at the best price but not below a certain price or agree to buy at or below a certain price • Does not guarantee that the purchase or sale will be made • Limit orders are filled in the order in which they are received

49. Secondary Markets for Stock • Stop order – type of limit order to sell a particular stock at the next available opportunity after its market price reaches a specified amount • Does not guarantee that it will be sold at the price you specified but it does guarantee that it will be sold at the next available opportunity

50. Secondary Markets for Stock • Commission Charges – brokerage firms charge a minimum…most are $25 - $55 for buying and selling stock • Additional fees can be charged based on the number shares and the value of the stock • Stocks are traded in round lots—100 shares or multiples of 100 shares of a particular stock • An odd lot contains fewer than 100 shares