Common Stock Investing

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Common Stock Investing

• Gitman-Joehnk
• Chapter 5

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Key Concepts

• Appeal of Common Stocks
• Historical Performance of Common Stocks
• Advantages Disadvantages of CS
• Key Characteristics of CS
• Buying and Selling CS
• Reading Stock Quotes
• Transactions Costs
• Common Stock Values
• Dividends
• Alternative CS Investment Strategies
• Classification of Stocks by Type

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Basic Characteristics
Each share of common stock represents
ownership/equity in the company. Generally
implies equal participation in earnings dividen
ds vote voice in management unless there are
different classes of stock
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Common Stock as a corporate security All
corporations must issue shares of common
stock. Common stock in most companies is never
traded firm is so small that there is no need
or market for its CS company is family owned
and controlled
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In publicly traded companies, common stock can
be issued in several ways public
offering rights offering stock split treasury
stock classified common stock
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• Basic Appeal of Common Stock
• enables investors to participate in the profits
  of a firm
• CS shareholders are residual owners of the
  company
• entitled to
• dividend income
• share of companys earnings, but only after
• all other corporate obligations have been
• met
• offers no guaranteeof a specific return on CS
• investment
• The Challenge is to find stocks that provide the
  kind
• return desired by the investor

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• CS investments can be tailored to meet
  individual
• needs and preferences given size and
• diversity of capital markets
• potential access to
• steady income (through dividends)
• wealth accumulation (capital gains)

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Advantages and Disadvantages Advantages can
provide highly competitive and attractive
returns CS - over last 40 years 10 per
year over last 5-10 years 10-15 per
yr. Corp Bonds - over last 40 years 6 per
yr. or less than 2/3s the return on CS CS
shareholders fully participate in residual profits
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(Advantages ) easy to buy and
sell transactions costs modest price market
information widely disseminated unit cost of
shares usually in reach of most investors bonds
often 5-10,000 denom. mutual funds often
require-500-1,000 to open acct.
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• Disadvantages
• biggest is the higher relative risk
• company earnings are subject to volatility
• from many factors that impact sales,
• revenues, profits
• wide fluctuations in performance make
• CS hard to value and, therefore,
• hard to consistently choose top performers
• future performance is always uncertain
• valuation methods are imperfect

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• (Disadvantages)
• CS lags behind many other investments in
  producing
• current income
• CS vs. Bonds- dividend yields almost always
• trail coupon yields

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Historical Performance (return) T-Bills
3.7 LT Bonds 4.8 Stock 10.3 Stocks
vs. Bonds Holding Period 1926-95 (in
yrs.) 1 60 5 77 10 89 20
98 30 100
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Historical Performance (risk) The stock market
remains a risky place to invest. Odds on losing
money over various holding periods as measured by
the SP 500 stock index Holding
Period probability of loss 1 26 3 14 5
10 10 3
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Stock Quotes Investors rely on highly
efficient information system to disseminate
market prices to the public. thus CS price
quotations are essential Most stock quotations
use standard format and symbolic
language. Consider the WSJ Stock Tables as an
Example
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WSJ example table goes here.
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Common Stock Values Par Value - stated or face
value of a share of CS not a measure of
anything except used in accounting as a
result, many stocks today are issued as no
par low par with par values of 1 to 2cents
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Book Value - accounting measure representing the
amount of stockholders equity in the
firm. BVE BVA - BVL - BVPS where BVEbook
value of equity (common stock) BVAbook value of
assets BVL book value of liabilities BVPS book
value of preferred stock on a per share basis
BVEper shareBVE/NSO
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Market Value-easiest of the common stock values
to find since it reflects the prevailing market
price at any point in time. Thus market value
is synonymous with the concensus view of the
Fair Mkt. Value Total market capitalization is
the product of market value and NSO
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Investment Value - most important measure for
an investor/stockholder indicates the worth
the investor places on the stock i.e. what
investors think the stock should sell
at determining this value is fairly
complex based upon expectations of the
risk-return behavior of the stock
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More on investment value
D is dividend per share P is investment value
(per share) dpr is dividend payout ratio EPS is
earnings per share ri is the required rate of
return t is time period t all are expectations
concern- ing future values
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Thus investment value depends on the expected
or required rate of return and the cash payouts
(primarily dividends) the investor expects to
receive in the future. Market places high value
on dividends if a company is going to retain
earnings, it should demonstrate proportionately
higher growth and profit levels if the
company is investing funds at a high rate of
return then retention is OK -- otherwise the
company should pay out profits to shareholders.
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Dividends As discussed, dividends are one of
two basic sources of return to common
stock dividends are generally paid on a
quarterly basis amount decided by Bd of Dir Bd
evaluates the firms operating results and
financial conditions to establish amount to be
paid and the dates of payment One key variable
is EPS - which translates corp. profits into
profits per share providing a convenient
measure of the earning that are available to
stockholders
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Dividends (more) Much of earnings may be needed
to finance growth so future growth prospects
will need to be assessed Cash position is
important - must be sufficient liquidity to
meet a cash dividend of the announced size. Bd.
must meet all legal contractural constraints
limit its ability to pay dividends
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Key Dates
Date of Declaration - The companys board of
directors announces that a dividend will be paid
on a certain date in the future.
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Key Dividend Dates Date of Record - date on
which the investor must be a registered
shareholder of the firm to receive a
dividend Payment Date - generally follows the
date of record by 1-to-2 weeks. It is the
actual date on which the dividend checks will be
mailed to holders of record Ex-Dividend Date -
this date will dictate whether a shareholder is
an official shareholder. If you sell stock
0n-or-after the ex-dividend date you receive the
dividend necessary from a bookkeeping standpoint
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Example Chronology January 3rd - Date of
Declaration January 13th - Ex-Dividend
Date January 18th - Date of Record January 28th
- Payment Date
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Form of Dividend Payment Cash Stock - has no
real value, represents the receipt of
something you already own (more shares, lower
share price) DRIP - Dividend reinvestment
plans dividends automatically reinvested into
additional shares of a companys stock usually
no commission taxed as ordinary income in year
received
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Alternative Investment Strategies Common Stocks
can be used for store of value - emphasis
on safety and protection of principal Blue
Chips nonspeculative, high quality
stocks accumulation of capital
(wealth) important goal for those with
long-term investment horizons use capital
gains and dividends to build wealth target both
growth and income stocks
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source of income - emphasize dependable flow
of dividends high yielding, good quality
income stocks (dividend yields are important
here
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Strategies Buy-and-Hold High Income Quality
LT Growth Aggressive Stock Management Speculativ
e and ST Trading
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Kinds of Stocks Blue Chip- large, well
established, financially sound Income- sustained
record of paying above avg. dividends Growth-s
ustained, high growth rate of operations and
earnings (15-18) usually low-to-no dividends S
peculative- lacks sustained records of success
but offers potential capital gains often
involves anticipation of a change Cyclical-
stock price moves with business cycle Defensive-
stock price is stable or counter-cyclical Mid-Cap
- 500m. m. Large-Cap- MVE 2-3 b.
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