chapter 12 investing in stocks - hurleyclasses.zonehurleyclasses.zone/finance/c12/chapter12.pdf ·...

Chapter

© 2010 South-Western, Cengage Learning

Investing in Stocks

12.1 Evaluating Stocks

12.2 Buying and Selling Stock

12

© 2010 South-Western, Cengage Learning SLIDE 3

Chapter 12

Owning Stock

Nearly 50 million people in the United States own stocks.

People who own shares of stock are called stockholders, or shareholders, of the corporation.

Two ways to profit from owning stock: Dividends are money paid to stockholders from the

corporation’s earnings (profits).

Capital gain is an increase in the value of the stock over time.


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Common Stock

Common stock represents a type of

stock that pays a variable dividend and

gives the holder voting rights.

A proxy is a stockholder’s written

authorization to transfer his or her voting

rights to someone else, usually a

company manager.

https://www.youtube.com/watch?v=43CZAE4bhUo


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Preferred Stock

Preferred stock represents a type of stock that pays a fixed dividend but has no voting rights.

Preferred stockholders earn the stated dividend, regardless of how the company is doing.

Preferred stock is less risky than common stock.


Class C shares (GOOG) have no voting

rights, while Class A shares (GOOGL)

have one vote each

Class B shares which do not trade in the

public market, are owned by insiders and

each get more than 1 vote up to

ten votes

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http://investorplace.com/stock-quotes/googl-stock-quote/


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Income stocks

Growth stocks

Emerging stocks

Blue chip stocks

Defensive stocks

Cyclical stocks

Types of Stock Investments


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Income Stocks

Income stocks are usually blue chip

stocks that have a consistent history of

paying high dividends and maintain it’s

value.

Apple, Chevron, Coke, Las Vegas

Sands, Lockheed Martin, Target, Wells

Fargo, WhirlPool


Growth Stocks Growth stocks are stocks in corporations

that reinvest their profits into the business

so that it can grow. Tesla Motors, GoPro

More likely to get a capital gain when buying these

stocks vs. a dividend.

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Emerging Stocks

and Blue Chip Stocks

Emerging stocks are stocks in young,

often small corporations that have higher

overall risk than stocks of companies that

have been successful for many years.


Blue chip stocks are stocks of large, well-

established corporations with a solid record

of profitability; uninterrupted history of

dividends; high quality.

Value is in the billions, generally a market

leader or among the top three companies in its

sector, and is more often than not a household

name – Boeing, MMM, DuPont, E. Li Lilly

term is believed to have been derived from

poker, where blue chips are the most

expensive chips

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Defensive Stocks

and Cyclical Stocks

A defensive stock, or non-cyclical stock,

is one that remains stable and pays

dividends during an economic decline

Things we need regardless of how economy

is doing.

Cyclical stocks do well when the

economy is stable or growing but often

do poorly during recessions, when the

economy slows down.


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Valuing Stock

The par value is an assigned dollar

value given to each share of stock.

Market value is the price for which the

stock is bought and sold in the

marketplace.


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Stock Price

Factors that affect price include:

The company – performance?

Interest rates – when rates are low (lower

than rate of inflation), people who would

normally put $ in savings, will buy stocks and

stock prices then to rise

The market – is company popular, items

selling well?

Earnings per share – used to measure’s a

company’s profitability.


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Return on Investment

Because you can make money on stocks from dividends and from an increase in the price of the stock (capital gain), you should consider both when computing the return on your investment.

Your profit is the difference between what you paid for the stock and what you sold it for, plus any dividends you earned.

To compute the total costs, add any commission you paid to the stockbroker to the purchase price of the stock.


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Stock Indexes A stock index is a benchmark that investors

use to judge the performance of their

investments.

index provides a summary of the overall

market by tracking some of the top stocks

within that market

Index in back of book – tells you what pg topic is

on


Commonly used indexes include:

Dow Jones Industrial Average (30 largest US

companies—large cap; leading indicator of market health)

Nov 2013 – 16,000 had never been higher

Jan 2015 – 17,400

Feb 2015 – 18,244

Now – 16,100

Standard & Poor’s 500 (500 large U.S. companies

across a span of industries; represent roughly 70 percent of all

the stocks that are publicly traded.)

NASDAQ Composite Index (usually tech companies

but not all – 1800flowers, starbucks, steve madden; tracks only

3,000 companies)

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The Securities Market Use to need a “trading agent”; now can do

on-line with an on-line acc’t.

A securities exchange is a marketplace

where brokers who are representing

investors meet to buy and sell securities

NYSE (1772), CHX (Chicago, 1882)

The over-the-counter (OTC) market is a

network of brokers who buy and sell the

stocks of corporations that are not listed on

a securities exchange--company may be too small

to meet the formal exchange listing requirements.


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Bull and Bear Markets—how do

they fight??? Up/Down A bull market is a prolonged period of rising

stock prices and a general feeling of investor

optimism. 3 or 4x longer than bear market

A bear market is a prolonged period of

falling stock prices and a general feeling of

investor pessimism. Short, savage period


Goal/objective

To make a profit…buy stock when price

is low and sell when high!!!

No one can no for sure

No magic crystal ball

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Investing Strategies

Short-term techniques -- risky

Buy on margin

Sell short

Long-term techniques – best return

Buy and hold

Dollar-cost averaging

Direct investment

Reinvesting dividend


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Buy on Margin

You can borrow money from your broker to buy stock if you open a margin account and sign a contract called a margin agreement.

Leverage is the use of borrowed money to buy securities.

When the market value of a margined stock decreases to approximately one-half of the original purchase price, the investor will receive a margin call from the broker. (bought stock on margin for $100/PS…when price fall to $50 the call is made)

This means the investor must pledge additional cash or securities to serve as collateral for the loan.


Example

You have $2,000 in your margin account

You wan to buy 100 shares @ $20/PS

You can use $1,000 from your margin acc’t

and borrow $1,000, with interest, from your

broker

This is leverage—the use of borrowed money

to buy stock.

You use less of your own money therefore

buying stocks with less.

Can use other $1,000 on margin to buy other

stock

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Why buy on margin

You are betting the stock will increase in

value. When it does, you sell the stock,

repay the loan AND interest and

commission, and take your short-term

profit.

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Sell Short Short selling is selling stock borrowed – not

money -- from a broker that must be replaced at a later time.

To sell short, you borrow a certain number of shares from the broker.

You then sell the borrowed stock, knowing that you must buy it back later and return it to the broker.

You are betting that the price will drop—opposite of margin, so that you can buy it back at a lower price than you sold it for, thus making a profit.


You have just return the stock shares –

100, 200, 300

NOT the price per share!!!

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Long-Term Investing Techniques

Buy and hold

Dollar-cost averaging

Direct investment

Reinvesting dividends


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Buy and Hold Most investors consider stock purchases as

long-term investments.

All stocks go up and down, but over a number of years, the overall trend is moderately up.

If you “buy and hold” stocks for many years, you can ride out the down times.

When you are ready to sell years later, most likely your stock will have gained value.

In addition, many stocks pay dividends, so you are earning income while you hold the stock.


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Dollar-cost Averaging

The dollar-cost averaging technique

involves the systematic purchase of an

equal dollar amount of the same stock at

regular intervals.

The result is usually a lower average cost

per share.


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Direct Investment

You can save money using direct

investment, or buying stock directly from

a corporation.

By buying directly, you avoid brokerage and

other purchasing fees.

You may also be able to obtain shares at

prices lower than on open exchanges.


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Reinvesting Dividends

Dividend reinvestment means using

dividends previously earned on the stock

to buy more shares.

Buying stock this way avoids a broker fee

and other costs that apply, such as taxes,

when you receive cash dividends on the

stock.


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Reading the Stock Listings

Excerpt from stock exchange listings: 52 Wks

Stock Div Yld%

P/E

Ratio

Sales

100s High Low Close

Net

Change High Low

1 2 3 4 5 6 7 8 9 10 11

58.75 44.00 Enger 2.20 4.8 12 109 46.38 45.50 46.00 –.50

45.00 23.00 Eng pf 2.25 8.9 10 25 26.25 24.00 25.38 +.38

10.50 9.00 Entld .10 1.0 3 8 10.13 9.50 10.00 ----

24.00 16.00 Epsco 1.00 5.0 7 12 21.00 19.00 20.00 +.88

6.38 4.00 Exlab ---- ---- 15 300z 5.75 5.12 5.50 ----

57.00 32.00 ExeB 2.50 5.7 11 48 46.00 43.00 44.00 +1.00

PG 275 – Yld% -- want high and P/E ratio – want high


Chapter 12

P/E – simply is to read value of a company; measures the level of confidence

investors have in a company and what they are willing to pay for $1 of

earnings. Investors are often willing to pay more for stocks with a high P/E

ratio because they expect the company to have high future returns or they

believe the company is growing faster than average. Higher P/E ratio's are

often associated with "growth stocks", or companies that are growing faster

than average.

Yield - income return on an investment and is usually expressed as a %.

Dividend yields are a measure of an investment’s productivity; view it like an

"interest rate" in your favor.

Earnings Per Share – use P/E and Yield instead

EPS is one of the benchmark factors that stock analysts use to determine a

company's financial health; changes in a company's EPS and revenue are

primary factors in influencing changes in the market price of a company's

stock.

At its most fundamental level, a company's earnings per share is simply the

amount of the company's profits divided by the number of outstanding shares

of stock. For example, if a company earned $12 million in profits and had 8

million outstanding shares, its EPS would be $1.50.


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EPS -- companies A and B both earn $100, but company A has 10 shares

outstanding, while company B has 50 shares outstanding. Which company’s

stock do you want to own?

It makes more sense to look at earnings per share (EPS) for use as a

comparison tool. You calculate earnings per share by taking the net earnings

and divide by the outstanding shares.

EPS = Net Earnings / Outstanding Shares Using our example above, Company

A had earnings of $100 and 10 shares outstanding, which equals an EPS of 10

($100 / 10 = 10). Company B had earnings of $100 and 50 shares outstanding,

which equals an EPS of 2 ($100 / 50 = 2).

So, you should go buy Company A with an EPS of 10, right? Maybe, but not just

on the basis of its EPS. The EPS is helpful in comparing one company to

another, assuming they are in the same industry, but it doesn’t tell you whether

it’s a good stock to buy or what the market thinks of it. For that information, we

need to look at some ratios


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If there is one number that people look at than more any other it is the Price to Earnings Ratio

(P/E).

The P/E looks at the relationship between the stock price and the company’s earnings. The P/E

is the most popular metric of stock analysis, although it is far from the only one you should

consider.

For example, a company with a share price of $40 and an EPS of 8 would have a P/E of 5 ($40

/ 8 = 5).

What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the

company’s earnings. The higher the P/E the more the market is willing to pay for the company’s

earnings.

high P/E may be an overpriced stock but can also indicate the market has high hopes for this

stock’s future and has bid up the price.

a low P/E may indicate a “vote of no confidence” by the market or it could mean this is a

sleeper that the market has overlooked.

What is the “right” P/E? There is no correct answer to this question, because part of the answer

depends on your willingness to pay for earnings.

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