Common Stocks

1. Common Stocks • Residual Owners: • Stockholders of a firm are entitled to dividend income derived from the firm’s earnings. • Stocks may provide a steady stream of current income through dividends. • Stocks may increase in value over time through capital gains.

3. Market Performance • Routine Decline: a drop of 5% or more in one of the major market indexes, like the Dow Jones Industrial Average (DJIA) • Correction: a drop of 10% or more in one of the major market indexes • Bear Market: a drop of 20% or more in one of the major market indexes

4. Stock Returns: Both price changes, called capital gains, and dividend income: • Over past 50 years, stock returns have ranged from +48.28% in 1954 to -21.45% in 1974 • Stock returns over past 50 years have averaged around 11% • From 1998 through mid-’03, DJIA averaged 1.7%

5. Provide opportunity for higher returns than other investments • Over past 50 years, stocks averaged 11% and high-grade corporate bonds averaged 6% • Good inflation hedge since returns typically exceed the rate of inflation • Easy to buy and sell stocks • Price and market information is easy to find in financial media • Unit cost per share of stock is low enough to encourage ownership

8. Stocks are subject to many different kinds of risk: • Business risk • Financial risk • Market risk • Event risk • Hard to predict which stocks will go up in value due to wide swings in profits and general stock market performance • Low current income compared to other investment alternatives

10. Stock Split: when a company increases the number of shares outstanding by exchanging a specified number of new shares of stock for each outstanding share • Usually done to lower the stock price to make it more attractive to investors • Stockholders end up with more shares of stock that sells for a lower price • Investor with 200 shares in a 2-for-1 stock split would have 400 shares after the stock split • If the stock price was $100 before the split, the price would be near $50 after the split

11. Treasury Stock: shares of stock that were originally sold by the company and have been repurchased by the company. Share repurchases are often called “buybacks.” • Reduces the number of shares outstanding to public • Companies buyback when they believe stock is undervalued and a good buy • Companies may try to raise undervalued stock price or prop up overvalued stock price • May be used for employee stock option plans

12. Classified Common Stock: common stock issued in different classes, each of which offers different privileges and benefits to its holders • Different shares may have different voting rights • Often used to allow a relatively small group to control the voting of a publicly-trade company • Ford family owns “B” shares and other investors own “A” shares; Ford family controls 40% of Ford Motor Company • May have different dividend payout schedules

14. Par Value: the stated, or face, value of a stock • Mainly an accounting term and not very useful to investors • Book Value: the amount of stockholders’ equity • The difference between the company’s assets minus the company’s liabilities and preferred stock • Market Value: the current price of the stock in the stock market

15. Market Capitalization: the overall current value of the company in the stock market • Total number of shares outstanding multiplied by the market value per share • Investment Value: the amount that investors believe the stock should be trading for, or what they think it’s worth • Probably the most important measure for a stockholder

16. Earnings Per Share: the amount of annual earnings available to common stockholders, stated on a per-share basis

17. Dividends • Dividend income is one of the two basic sources of return to investors. • Dividend income is more predictable than capital gains, so preferred by investors seeking lower risk. • Dividends are taxed at maximum 15% tax rate, same as capital gains. • Dividends tend to increase over time as companies’ earnings grow; increases average 3-5% per year. • Dividends represent the return of part of the profit of the company to the owners, the stockholders.

18. Dividend Payout Ratio: the portion of earnings per share (EPS) that a firm pays out as dividends • Companies are not required to pay dividends • Some companies have high EPS, but reinvest all money back into company

19. Key Dates for Dividends

20. Dividends and Dividend Yield • Dividend Yield: a measure to relate dividends to share price on a percentage basis • Indicates the rate of current income earned on the investment dollar • Convenient method to compare income return to other investment alternatives

21. Stock Dividend: payment of a dividend in the form of additional shares of stock • Dividend Reinvestment Plans (DRIPs): plans where cash dividends are automatically reinvested into additional shares of the firm’s common stock • Over 1,000 companies offer DRIPs • Usually have no brokerage fees • Uses dollar-cost averaging

22. Blue Chip Stocks: financially strong, high-quality stocks with long and stable records of earnings and dividends • Companies are leaders in their industries • Relatively lower risk due to financial stability of company • Popular with investing public looking for steady growth potential, perhaps dividend income • Provide shelter during unsettled markets • Examples: Wal-Mart, Proctor & Gamble, Microsoft, United Parcel Service, Pfizer and 3M Company

23. A Blue Chip Stock

24. Income Stocks: stocks with long and sustained records of paying higher-than average dividends • Dividends tend to increase over time (unlike interest payments on bonds) • Examples: Verizon, Conagra Foods, Pitney Bowes.

26. Growth Stocks: stocks that experience high rates of growth in operations and earnings • Investors expect higher price appreciation due to increasing earnings; pay little or no dividends • Examples: Lowe’s, Harley-Davidson, Starbucks, Kohls

28. Speculative Stocks: stocks that offer potential for substantial price appreciation, usually due to some special situation such as a new product. • Examples: Chipotle, P.F. Chang’s, Quicksilver.

30. Tech Stocks: stocks representing the technology sector of the market • Small companies that have never shown a profit and blue chip stocks of large companies that are growth-oriented • Difficult to put value on due to erratic or no earnings • Examples: Microsoft, Cisco Systems, Dell.

32. Cyclical Stocks: stocks whose earnings and overall market performance are closely linked to the general state of the economy • Best for investors willing to move in and out of market as economy changes • Examples: Caterpillar, Maytag Corp.

34. Defensive Stocks: stocks that tend to hold their value, and even do well, when the economy starts to falter • Stock price remains stable or increases when general economy is slowing • Products are staples that people use in good times and bad times, such as electricity, beverages, foods and drugs; Gold stocks. • Best for aggressive investors looking for “parking place” during slow economy • Examples: Proctor & Gamble, WD-40

36. Market Capitalization • Small-Cap Stocks: under $1 billion • Mid-Cap Stocks: $1 billion to $4 or $5 billion • Large-Cap Stocks: more than $4 or $5 billion

37. Small-Cap Stocks: small companies with market capitalizations less than $1 billion • Provide opportunity for above-average returns (or losses) • Usually do not have a financial track record • Earnings tend to grow in spurts and can have dramatic impact on stock price • Usually not widely-traded; liquidity is issue • Examples: Rubio’s, Hot Topic, Sonic Corp.

38. Mid-Cap Stocks: medium-sized companies with market capitalizations between $1 billion and $4 or $5 billion • Provide opportunity for greater capital appreciation than Large-Cap stocks, but less price volatility than Small-Cap stocks • Usually have long-term track records for profits and stock valuation • “Baby Blues” offer same characteristics of Blue Chip stocks except size • Examples: Wendy’s, Barnes & Noble, Petsmart, Cheesecake Factory

39. Large-Cap Stocks: large companies with market capitalizations over $4 or $5 billion • Number of companies is smaller, but account for 80% to 90% of the total market value of all U.S. equities • Bigger is not necessarily better • Tend to lag behind small-cap and mid-cap stocks, but typically have less volatility • Examples: AT&T, General Motors, Microsoft

40. Investing in Foreign Stocks • Globalization of financial markets is growing • U.S. equity market is less than 50% of world equity markets • Six countries make up 80% of world equity market • U.S. market remains largest and one of best performing equity markets • Much of performance of non-U.S. markets is due to changes in currency exchange rates

41. Going Global • International investing is more complex and riskier than domestic investing • International investing requires investors to be right on more factors: • Must pick right stock • Must pick right market • Must pick correct direction for currency exchange rate fluctuations

42. Returns on International Investments • Stronger U.S. dollar has negative impact on foreign investments • Weaker U.S. dollar has positive impact on foreign investments

43. Stock Investment Strategies • Buy-and-Hold • Investors buy high-quality stocks and hold them for extended time periods • Goal may be current income and/or capital gains • Investors often add to existing stocks over time • Very conservative approach; value-oriented

44. Strategies • Current Income • Investors buy stocks that have high dividend yields • Safety of principal and stability of income are primary goals • May be preferable to bonds because dividends levels tend to increase over time • Often used to provide to supplement other income, such as in retirement

45. Strategies • Quality Long-Term Growth • Investors buy high-quality growth stocks, mid-cap stocks and tech stocks • Capital gains are primary goal • Higher level of risk due to emphasis on capital gains • Significant trading of stocks may occur over time • Diversification is used to spread risk • “Total Return Approach” is version that emphasizes both capital gains and high income

46. Strategies • Aggressive Stock Management • Investors buy high-quality growth stocks, blue chip stocks, mid-cap stocks, tech stocks and cyclical stocks • Capital gains are primary goal • High level of risk due to emphasis on capital gains • Investors aggressively trade in and out of stocks, often holding for short periods • Timing the market is key element • Time consuming to manage

47. Strategies • Speculation and Short-Term Trading • Also called “day trading” • Buy speculative stocks, small-cap stocks and tech stocks • Capital gains are primary goal • High risk due to emphasis on capital gains in short time period • Trade in and out of stocks, often holding for extremely short periods • Looking for “big score” on unknown stock • Time consuming & high trading costs

48. Review • The investment appeal of common stocks. • Historical stock returns and how measured. • Dividends. • Different kinds of common stock values. • Types of common stocks. • Strategies.