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12 Investing in Stocks. Stocks – shares of ownership in the assets and earnings of a business corporation. Common Stock – the most basic form of ownership of a corporation. Shareholder – the owner of a stock.

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12 investing in stocks
12 Investing in Stocks
  • Stocks – shares of ownership in the assets and earnings of a business corporation.
  • Common Stock – the most basic form of ownership of a corporation.
  • Shareholder – the owner of a stock.
  • Voting Rights – proportionate authority to express a choice in matters affecting the company.
  • Proxy – written authorization given by shareholder to someone else to represent him or her and vote his or her shares at a stockholder’s meeting.


objective 1 identify the most important features of common and preferred stocks
Objective 1 Identify the Most Important Features of Common and Preferred Stocks
  • Two types of stock
    • Common Stock- provides investors with an ownership interest in a corporation or (growth oriented)
    • Preferred Stock- a cross between a stock and a bond (income oriented)
  • On average, common stocks have outperformed all other assets over time
  • Need to be patient and do research



Why Corporations Issue

Common Stock

  • Common Stock = most basic form of corporate ownership
  • Stock = equity financing
  • Reasons why corporations issue stock
    • Raise money to start or expand business
    • Pay ongoing business expenses
    • Need not repay the money (like bonds)
    • Dividends (distributionsto shareholders) not mandatory
      • Board of Directors votes each dividend payment
  • But:
    • Shareholders have voting rights; control of company
    • Management must often make concessions



Why Investors Purchase

Common Stock

Investors can make money in three ways

    • Income from dividends
    • Dollar appreciation of stock value
      • Price appreciation = capital gain
    • Possible increased value from stock splits
      • No guarantee price will go up after a split
  • Stock Split – when the shares of stock owned by existing shareholders are divided into a larger number of shares; done to change (lower) price
    • Example: 2:1- twice as many shares worth half as much
  • A reverse stock split results in smaller number of shares.
    • Example: 1:2- half as many shares worth twice as much


dividend dates
Dividend Dates
  • Declaration Date = Board of Directors votes to pay a dividend (usually quarterly)
  • Record Date = A stockholder must be registered on the firm’s books to receive the dividend
  • Ex-Dividend Date = 2nd day before the record date; stock begins to trade without the dividend
    • Investors buying after the ex-dividend date do not receive a dividend for that quarter
  • Payment Date = Dividend is paid to investors


preferred stock
Preferred Stock
  • Hybrid Security
    • Known cash dividend is about equal to bond interest
    • Equity position is about equal to common stock but usually non-voting; low % of all stock issued
  • Dividends paid before common stock
    • Dividend may be omitted
  • Cumulative Preferred Stock
    • Unpaid cash dividends accumulate
    • Must be paid before any cash dividends are paid to common stockholders (versus noncumulative preferred stock)
  • Convertible Preferred Stock
    • Can be traded for shares of common stock
    • Provides investor with added safety of preferred stock and greater speculative gain through conversion to common stock


classifications of stocks
Classifications of Stocks
  • Income Stock – may not grow too quickly, but pays a cash dividend higher than that offered by most companies year after year.
    • Example: utility companies
  • Growth Stock – a company that offers the promise of much higher profits tomorrow and has a consistent record of relatively rapid growth in earnings in all economic conditions.
    • Example: technology companies
more classifications of stocks
More Classifications of Stocks
  • Speculative Stock – a company that has a potential for substantial earnings in the future.
  • Blue-Chip Stocks – a company that has been around for a long time, has a well-regarded reputation, dominates its industry, and is known for being a solid, relatively safe investment.
  • Value Stock – a company with stock that is selling for less than the true worth of its assets.
other characterizations for common stocks continued
Other Characterizations for Common Stocks (continued)
  • Cyclical Stocks – stock from a company whose profits are greatly influenced by changes in the economic business cycle.
    • Examples?
  • Countercyclical (or Defensive) Stocks – stock from a company that performs well even in an environment characterized by weak economic activity.
    • Examples?
objective 2 explain how you can evaluate stock investments
Objective 2Explain How You Can Evaluate Stock Investments
  • The Internet
    • Firm’s home page more current than printed materials
    • http://finance.yahoo.com
  • Stock Advisory Services
    • Most charge a fee
    • Three most popular: Standard and Poor’s reports, Value Line and Mergent’s Handbook of Common Stock
  • Prospectus- Lists all necessary information as dictated by the Federal government
  • Annual Report- All publicly traded corporations send to their stockholders
  • Securities and Exchange Commission Web site (http://www.sec.gov)
  • Business Periodicals:
    • Business Week, Fortune, Forbes, Money, Smart Money, Kiplinger’s Personal Finance Magazine


objective 3 analyze the numerical measures that cause a stock to increase or decrease in value
Objective 3Analyze the Numerical Measures that Cause a Stock to Increase or Decrease in Value
  • Corporate Earnings
    • One of the most significant factors in changes in the value of a stock
  • Earnings per share(EPS)
    • Formula: Corporation’s after-tax income divided by number of outstanding shares of common stock
    • Example: $5,000,000/10,000.000 = $0.50
    • EPS Increase = generally a healthy sign


numeric measures that influence investment
Numeric Measures That Influence Investment
  • Price-Earnings Ratio (PE)
    • Price per share of stock divided by the firm’s earnings per share
    • Example: $10 price/0.50 EPS = a PE ratio of 20
    • Tells how much an investor is paying for a company’s earning power
    • P/E > 20  investor optimism
    • P/E < 20  lower earnings expectations
    • Compare to firms in same industry
  • Projected Earnings
    • EPS and PE based on historical data
    • Future expectations more relevant


common stock price quotes
Common Stock Price Quotes

Last trade price = $44.37 Annual dividend = $1.68

P/E = 15.41 Earnings per share = 44.37/15.41 = $2.8793


other factors than influence the price of a stock
Other Factors than Influence the Price of a Stock
  • Dividend Yield
    • Annual dollar dividend divided by current price per share
    • Dividend yield increase = healthy sign
  • Total Return
    • Dividends plus capital gains
    • Cash income + Price appreciation
  • Book Value per Share
    • (Assets – Liabilities)/ # shares (net worth of company)
    • Market price per share should be > book value


objective 4 describe how stocks are bought and sold
Objective 4DescribeHow Stocks are Bought and Sold

Primary Market

  • Investor buys securities from issuer of those securities via an investment bank
    • Investment bank = financial firm that assists corporations in raising funds, usually by helping sell new security issues (underwriting)
  • IPO = when a corporation sells stock to general public for first time
    • Cash from security sales goes to issuing company
    • Generally considered a high-risk investment

Secondary Market

  • Market for existing financial securities
  • Traded among investors via brokers and dealers
  • Markets
    • Stock exchanges (NYSE, foreign securities exchanges)
    • Over-the-counter markets


secondary markets for stocks
Secondary Markets for Stocks

Securities Exchanges (NYSE)

  • Marketplace where members, representing investors, meet to buy and sell securities (almost 4,000 companies)
  • Securities sold on an exchange must be listed, or accepted for trading, on that exchange
  • “The Listed Market” = NYSE
  • “Specialist” buys or sells a particular stock

The Over-the-Counter (OTC) Market (NASDAQ)

  • Network of dealers who buy and sell the stocks of companies from inventory (several thousand companies)
    • Dealer = “Market Maker”
  • NASDAQ = electronic marketplace for over 3,200 companies


brokerage firms and account executives
Brokerage Firms and Account Executives
  • Account Executive (Stockbroker)
    • Licensed individual who buys and sells securities for his or her clients
  • Churning
    • Excessive buying and selling of securities to generate commissions
    • Illegal under SEC regulations
    • Can be difficult to prove; clients subject to arbitration


discount vs full service brokers service vs cost
Discount vs. Full Service BrokersService vs. Cost
  • How much advice do you want?
  • Can you buy and sell stocks over the phone?
  • Can you trade stocks online?
  • Where is the nearest office located?
  • Toll-free number for customer use?
  • How often are statements issued?
  • Is there a charge for statements, research reports, and other financial reports?
  • Are there any fees in addition to commissions to buy and sell?


computerized transactions
Computerized Transactions

Reasons that justify trading online:

  • Size of investment portfolio
  • Ability and desire to manage own portfolio
  • Ability to monitor investments closely
  • Capability of computer and software


stock transaction orders
Stock Transaction Orders
  • Market Order
    • Request to buy or sell stock at the current market value
  • Limit Order
    • Request to buy or sell a stock at a specified price
  • Stop Order(Stop-loss order)
    • Request to sell a stock at the next available opportunity after its market price reaches a specified amount
    • Can lose a lot of money in a “flash crash”
  • Brokerage minimum commissions
    • Range = $7 to $35
    • Depends on the number of shares traded and stock value
  • Full service vs. discount brokers
    • Full service fees > 1% to 2% of transaction amount
    • Online broker little advice or service


objective 5 explain the trading techniques used by long term investors and short term speculators
Objective 5Explain the Trading Techniques Used by Long-term Investors and Short-term Speculators

Long-Term Investment Strategies

  • Buy and hold
  • Dollar cost averaging
  • Direct investment and dividend reinvestment plans (DRIPS)
    • http://www.directinvesting.com
    • http://www.dripcentral.com


dollar cost averaging
Dollar Cost Averaging
  • Long-term technique
  • Invest equal dollar amount in the same stock at equal intervals
  • Goals:
    • Minimize average cost per share
    • Avoid “Buy High – Sell Low”


short term investment strategies
Short-Term Investment Strategies
  • Buying Stock on Margin
    • Borrowing money from broker
    • Margin requirement set by the Fed
    • “Bullish” (expect stock price increase)
  • Selling short
    • Borrowing stock to sell
    • “Sell high, buy low”
    • “Bearish” (expect stock market decrease)


wrap up
Wrap Up
  • Chapter Quiz
  • Concept Check 12-1- Common Stock and Preferred Stock
  • Concept Check 12-2-Prospectus and Annual Report
  • Figure It Out- Earnings per Share, PE Ratio, Dividend Yield
  • Concept Check 12-4- How Would You Buy Stock?