12 Investing in Stocks

1. 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. 12-1

2. 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 12-2

3. 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 12-3

4. 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 12-4

5. 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 12-5

6. 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 12-6

7. 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

8. 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.

9. 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?

10. 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 12-10

11. 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 12-11

12. 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 12-12

13. 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 12-13

14. 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 12-14

15. 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 12-15

16. 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 12-16

17. 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 12-17

18. 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? 12-18

19. 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 12-19

20. 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 12-20

21. 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 12-21

22. 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” 12-22

23. 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) 12-23

24. 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?