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Orange Empire Railway Museum: L.A. Railway LARy-3001, entered service in 1937, dedicated by child film star Shirley Temple.

Stock (Equity) FundamentalsStock (Equity) FundamentalsEssential features of pricing, Essential features of pricing,

buying, venue buying, venue (c) 2009-2013, Gary R. Evans. May be used for non-profit educational purposes only without author's permission.

About stocksAbout stocks• Nearly 13,000 companies listed on the major exchanges in the

U.S.– 8,000 NYSE Euronext and 5,000 NASDAQ OMX (in North America only)

• Many are overseas companies listed as ADRs (American

More will be said about exchanges next lecture.

y p (Depository Receipts)– Royal Dutch Shell (RDS-A), America Movil (AMX), Royal Bank of

Scotland (RBS), Sony (SNE), BP plc (BP)

• ETrade and other online brokerages also allows you to trade foreign stocks on foreign exchanges in their currencies!

• 4-5 letter listings (VRTX) typically NASDAQ, fewer (IBM, F) g ( ) yp y Q, ( , )are NYSE– Some (MSFT) are listed on both

• Becoming a global, 24-hour market slowly

• NYSE (NYX) and NASDAQ (NDAQ) are stocks!NYX opened at 13.60 on August 20, 2004, and was trading at 106 on Jan 17, 2007. Now 42.39 on Sep 4, 2013

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What is a market index?What is a market index?

• An index is a weighted and summed list of stocks that is meant to indicate a measure of performance for a certain class of stocks.

• Most stock indexes are weighted by market cap, shares outstanding times price (DJIA not).

• Weights are adjusted for splits, mergers and acquisitions, and additions and deletions from the list.

• Most indexes are now represented by ETFs.

• The major indexes are represented by mutual funds.

The Major Stock IndexesThe Major Stock Indexes

• The Dow-Jones Industrial Averageg

• The NASDAQ Composite (and 100)

• The S&P 500

• The Russell 2000 (small cap)(small cap)

• The Russell 6000

• Various sector indexes

• Various global indexesSource: bigcharts.com

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The Dow Jones Industrial AverageThe Dow Jones Industrial Average

AA Alcoa HD Home Depot MSFT MicrosoftAXP American Express HPQ Hewlett Packard PFE Pfizer

Dow Jones Industrial Average 30 components

AXP American Express HPQ Hewlett Packard PFE PfizerBA Boeing IBM IBM PG Procter GambleBAC Bank of America INTC Intel T AT&TCAT Caterpillar JNJ Johnson & Johnson TRV The Travelers Cos.CSCO Cisco JPM JP Morgan Chase UNH UnitedHealth GroupCVX Chevron Corporation KO Coca Cola UTX United TechnolgiesDD Du Pont MCD McDonalds VZ VerizonDIS Disney MMM 3M WMT Wal MartGE General Electric MRK Merck XOM Exxon Mobile

Stocks that have been removed in recent years include Altria (MO), Honeywell (HON), AIG, Citigroup (C), and General Motors (GM)m Kraft food (KFT). Stocks in this index are equally weighted.

Relative Index PerformanceRelative Index PerformanceDJIA vs. Russell 2000, Three years (DJIA vs. Russell 2000, Three years (9/4/13)9/4/13)

DJIA i bl kDJIA is black

Source: bigcharts.com

DJIA is 30 large cap industrials whereas Russell 2000 is small caps only. Over this time period the small caps are clearly more volatile.

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Basic information about your stock ...Basic information about your stock ...INTC

Go to yahoo or google to see what is there ...

It starts with the IPO ... It starts with the IPO ... (see the reading)(see the reading)

The stock is released to the public for the first time

th d fon the day of the Initial Public Offering (IPO). Thereafter the stock is traded in a the secondary market. That is the stock market.

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Tesla Tesla Motors (TSLA) Price History Since the IPO Motors (TSLA) Price History Since the IPO

140

160

180

60

80

100

120

140

I would sell the TSLA right now. I admire Musk and his wonderful car - would love to own one (wife says no) but financially it is a pure subsidy play. Depending upon whose numbers you believe, somewhere between $20K and $35K of actual price of each Tesla is subsidized by clean air credits, which means that their profits are 100%+ subsidy, and that sort of thing can disappear

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20

40

6/29/2010 10/29/2010 2/28/2011 6/30/2011 10/31/2011 2/29/2012 6/30/2012 10/31/2012 2/28/2013 6/30/2013

in a single evening. Don't get me wrong, I approve of Tesla and the subsidy, but it makes for very tenuous business. (Email to Chris Streiter May 9, 2013)

IPO Glory DaysIPO Glory Days... prior to the 2000 dot.com crash... prior to the 2000 dot.com crash

The 10 Most Successful First-day IPOs(as measured by percentage gains in the first day)

Company IPO Date IPO Price $ 1st day close Gain %TheGlobe.com November 13, 1998 9 63.50 606Braodcast.com July 17, 1998 18 62.75 249EarthWeb November 11, 1998 14 48.69 248Secure Computing November 17, 1995 16 48.25 202EBay September 24, 1998 18 47.38 163Yahoo April 12, 1996 13 33.00 154R b M 13 1997 12 30 25 152

( y p g g y)

Rambus May 13, 1997 12 30.25 152Boston Chicken November 8, 1993 20 48.50 143Planning Sciences April 30, 1996 10 24.13 141Home Shopping Net May 13, 1986 18 42.63 137

Source: Los Angeles Times , November 14, 1998. Original data source was Securities Data.

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The The FacebookFacebook IPO IPO last last summer ...summer ...

35.00

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Lawsuits forever ...

First day IPO trades are potentially very hazardous and are restricted. You are not allowed to trade first day in retirement accounts like IRAs, for example.

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5/18 5/25 6/1 6/8 6/15 6/22 6/29 7/6 7/13 7/20 7/27 8/3 8/10 8/17 8/24 8/31

The Diamond Foods IPOThe Diamond Foods IPO

This was a one-day trade and an example of “day trading ”

I bought here (20.58)

I sold here (21.50)

example of day-trading.

The hot IPO of summer 2013 was SFM, which soared from 18 to 40 on IPO day, but languished since.

One of my successful IPOs from the old days (the best ever was LVS, Las Vegas Sands). Central Valley almond growers. This was supposed to go out at about 18. Notice how it fell considerably before it started to rise. Some of these fall considerably, and keep falling! July 21, 2005. DMND. Last year 90!! 9/3/13: 21.64.

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Order routingOrder routing

Your limit or market order

Broker (Ameritrade)

Exchange (NYSE Arca)

Order-flow Market Maker(Knight Capital)

(or)

Quotation Service Clearing House

BrokersBrokers• Discount/online

– Low transactions costs, instant execution

– ETrade, Ameritrade, Scottrade, TradeKing

• Traditional full-service– "Private clients" charge 1% or so of assets

– Useful for very large accounts and clueless investors

– Track record rather motley in 2000 crash.

• Specialized onlineSpecialized online– Allow exotic online interfaces for day-trades, options

trading, programmed trading strategies

• Small-market traditional rip-off brokers– for ignorant people

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Assignment: Peruse Scottrade, E*Trade, and TDAmeritrade1. Fees for trading2. Trading platforms2. Trading platforms3. Requirements to

open an account

The primary role of the broker ... executing The primary role of the broker ... executing your buy and sell orders ...your buy and sell orders ...

Figure 1 Figure 1 –– Segment of an Ameritrade Trading Screen Showing Segment of an Ameritrade Trading Screen Showing Best Bid and Best Ask for Intel (INTC)Best Bid and Best Ask for Intel (INTC)

from chapter 2

A market order to BUY will be executed at Best Ask ($18.37 per share) and a market order to SELL will be executed at Best Bid ($18.36 per share).

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Ameritrade Online Trading ScreenAmeritrade Online Trading Screen

Enter these

C ld l b k tCould also be a market order, price box disappears

Types of ordersTypes of orders• Market order

– An order for the broker to buy a stock at the best possible price.

• Limit order– An order to buy <sell> a stock only if the price falls

below <above> some specified price.– Example: Buy MARY at $29 or below.

• Stop loss order– (For a stock already owned) Sell at market if the price(For a stock already owned) Sell at market if the price

falls below $26.

• Stop Limit Order– Combination of a limit order and a stop order: place a

limit order at X if the stock falls below X (or Y).

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The distinction between a limit and market order ...The distinction between a limit and market order ...

Figure 2 Figure 2 –– Ameritrade Ticket to Buy 100 shares of INTC with a Market Ameritrade Ticket to Buy 100 shares of INTC with a Market Order (Top) and a Limit Order (Bottom)Order (Top) and a Limit Order (Bottom)

Best Bid / Best AskBest Bid / Best Ask• Best Bid

– Of the limit orders submitted to buy stock, this i ( d t b ) th hi h t Thi i l tis (supposed to be) the highest. This is relevant to you if you are trying to sell the stock with a market order.

• Best Ask– Of the limit orders submitted to sell stock, this

is (supposed to be) the lowest. This is relevant to you if you are trying to buy the stock with a market order.

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National Best Bid and Offer [ask] (NBBO)National Best Bid and Offer [ask] (NBBO)Market and limit orders can be routed by many brokers through many market makers and other major transactors to any one of four exchanges in the United States. So how does a single Level II queue and, more important, how does a single Best Bid and Best Ask price emerge from this?g p g

Since 1978 an organization called the Securities Industry Automation Corporation (SIAC) has executed a protocol called the Consolidated Quote Plan resulting in the Consolidated Quotation System (CQS). As part of this service CQS identifies the “Best Bid and Offer” (highest bid and lowest ask), which is disseminated by SIAC to subscribing market participants (including your broker) through the CQS Multicast Line.

Thi NBBO t i h t li t di it h k fThis NBBO quote is what you see on an online trading site when you ask for a quote. This is also called a Level 1 quote. Normally this system insures that no matter what exchange or ECN your broker trades through, you will get best bid or best ask on market orders to sell or buy

.

Other terms you should know Other terms you should know (from the reading)(from the reading)

• Round lot

• Odd lot• Odd lot

• Block trade

• Splits

• Margin account

• GTD/GTC• GTD/GTC

• Day + EXT

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NASDAQ Level II / DOM QuotationsNASDAQ Level II / DOM Quotations

A limit order to buy (sell) will be placed in the bid (ask) queue wherever it belongs.

A market order to buy will (normally) be executed at Best Ask (the top of the

DOM: Depth of Market - other terms also now used.

Best Ask (the top of the ask queue).

Market Participant IDs (MPID)

(highest on top) (lowest on top)

Best Buy and Best Ask are shown in yellow.

Typical Level II screen (Ameritrade) showing Bid/Ask queue for Ford with Best Bid (11.64) and Best Ask (11.65) at t Bidtop. Bid queue represents limit orders to buy, Ask, to sell. The Bid queue declines and Ask queue rises.

(Sept. 1, 2010)

Limit orders make up the queues – you are being shown the best order for each exchange or market maker.

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This is NASDAQ’s Total View, shown on Ameritrade, which shows the DOM on theshows the DOM on the NASDAQ market only.

Sept 1, 2010 for Intel, very heavily traded (see daily volume) and so the queue is very tight with large combined orderscombined orders.

More on Limit vs. Market OrdersMore on Limit vs. Market OrdersA market order to buy (sell) in an ordinary stock transaction will normally result in the immediate purchase of your stock at Best Ask (Bid). In an orderly market for a liquid stock where there is only a penny spread between bid and ask a market order is suitable.

However, in a market for a less liquid stock there is often a wider spread between bid and ask. A limit order priced between bid and ask, or at least no higher than best ask when buying or no lower than best bid when selling, may be more suitable than a market order.

In a high-volume volume volatile market when the bid/ask queue is racing, you must use a limit order or you might end up getting a price you really don't want!don t want!

When trading first day IPOs, options, futures and other derivatives, again you must use limit orders and get very good at doing that.

Rule of thumb: if trading practice using limit orders even in a stable market when market orders will suffice.

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Illiquid Stocks and Illiquid Stocks and Big SpreadsBig Spreads

(and why you must use limit (and why you must use limit orders sometimes)orders sometimes)

NATH is a relatively illiquid stock (only 1900 shares at noon on Sep 1, 2010 – compare to INTC on same day) so there is a big spread between Bid (15.50) and A k (15 56) dAsk (15.56) and sometimes the spread is a lot wider than this. You may want to accept 15.56, or put a limit to buy at 15.52.

Short SellingShort Selling

1 S ll h

When you short-sell a stock you reverse the normal order of the transaction: (1) you sell the1. Sell here

2. Buy here

the transaction: (1) you sell the stock first, then (2) buy it back later.

Normally you do this because you think the price of the stock will fall.

H i thi ibl ? T h i ll h k thi t ti bHow is this possible? Technically when you make this transaction you borrowthe stock in-kind and offer collateral in cash and you promise to pay the stock back in-kind and have the collateral returned. You borrow it (indirectly usually) from a party who is long in the stock for the long term (like a pension fund) and is willing to loan it to you, using your collateral to earn a small return.

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Ameritrade shortAmeritrade short--selling processselling process

1. Initiate with this now.

2. Close the transaction with this later.

Securities Lending and Short SellingSecurities Lending and Short Selling

Securities Lender: Broker:Broker:You

Stock loanStock loan

Pension, Mutual, Hedge Fund. etc.

Ameritrade, Etrade etc.

You (seller)

Buyer

CashCashStockStock

Cash CollateralCash Collateral

Cash investedCash invested

The original securities lenders will be typically large institutional investors like pension funds or mutual fundsinstitutional investors like pension funds or mutual funds who plan to hold the stock in question for a very long

time, like an S&P500 Index mutual fund. Therefore they are willing to lend that stock through an intermediary (the broker) so long as cash collateral is provided. They then take that cash collateral and invest it in a low-yield safe investment to enhance yield. Often (typically) there is a custodian bank offering a securities lending program, lending the securities and finding investments, for the securities lender (not shown).

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Short sale dataShort sale data

• Short Ratio– The number of shares sold short divided by

d il t di laverage daily trading volume.

• Days Short (same thing)– Given average daily volume, the number of

days it would take to clear off (reverse) all short sales

• Short % of float– Percentage of all shares outstanding that are

short

– Levels as high as 50% were seen in 2008.

Stock splits and Stock splits and reverse splits reverse splits

(see the material in Chapter 1, especially for the discussion of

(Image from CNNMoney)

especially for the discussion of reverse stock splits, which aren’t covered in this lecture)

A board of directors can choose, with shareholder approval, to split a stock 2-for-1 or 3-for-1 or some other proportion to reduce the price back to a range that may be more attractive to investors.

The amount owned and dividends and other rights are adjusted proportionately. Google is proposing a controversial 2-1 split right now, controversial because they want to eliminate voting rights for the new class of stock.

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The Cabot Oil & Gas (COG) 2The Cabot Oil & Gas (COG) 2--forfor--1 split1 split(Aug 15, 2013)(Aug 15, 2013)

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90.00 Use “stock split calendar” in Google to find these ...

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8/1/2013 8/6/2013 8/11/2013 8/16/2013 8/21/2013 8/26/2013 8/31/2013

Actual Market Price Adjusted quoted price

In historical data series, the “adjusted” data will always account for the split (red line) so older data do not actually reflect the price that the stock was trading at.