Chapter 14: Investing in Stocks

1
Chapter 14 Investing in Stocks
2
Objectives

• Describe stocks and how they are used by
  corporations and investors.
• Define everyday terms in the language of stock
  investing.
• Classify stock according to their basic
  descriptive categories.

3
Stocks and Bonds and How They are Used

• Common stock
• Voting rights
• Proxy Vote
• Preferred stock
• Cumulative
• Convertible

4
Investing in Stocks

• Why do corporations issue common stock?
• To raise money to start or expand a business
• To help pay for ongoing business expenses
• They dont have to repay the money
• Dividends are not mandatory
• Stockholders have voting rights

5
Why Do Investors Purchase Stock?

• Income from dividends
• Record Date
• Ex-dividends
• Dollar appreciationof stock value
• Increased value from stock splits

6
Return on Investment
Assumptions 100 shares of common stock purchased
April 18, 2014, sole April 18, 2015 total
dividends of 2.21 per share for the investment
period.
Cost when Purchased Return when Sold
100 shares _at_ 42.75 4,275 100 shares _at_ 56.25 5,625
Plus commission 29 Minus commission - 34
Total investment 4,304 Total return 5,591
Transaction Summary
Total return 5,591
Minus total investment - 4,304
Profit from stock sale 1,287
Plus dividends 221
Total return for the transaction 1,508
7
Common vs. Preferred Stock

• Common stock
• get dividends depending on profit the company
  makes
• Preferred stock
• receive cash dividends before common stock
  holders
• pre-determined dividend rate
• most preferred stock is callable

8
Features of Preferred Stock

• Cumulative preferred stock
• unpaid cash dividends accumulate and are paid
  before cash dividends to common stock holders
• Participation feature
• rare form of investment
• can share in earnings beyond stated dividend
  amount
• Conversion feature
• can be traded for shares of common stock

9
Classifications of Common Stock

• Income stocks
• Growth stocks
• Cyclical stocks
• Defensive stocks
• Large cap stocks
• Capital gt 5 billion
• Mid cap stocks
• Capital between 1 billion and 5 billion
• Small cap stocks
• Penny stocks

10
Types of Stock Investments

• Blue chip stock
• low risk
• consistent dividends
• ex. ATT, Kellogg's, General Electric
• Income stock
• higher than average dividends
• ex. utility stock

11
Types of Stock Investments
(continued)

• Growth stock -
• earns above average profits
• low or no dividends
• Profits reinvested incompany, so...
• Stock priceshould go up
• ex. Microsoft or Intel

12
Types of Stock Investments
(continued)

• Cyclical stock
• follows business cycles of advance and declines
  in the economy
• ex. new construction, cars, timber
• Defensive stock
• remains stable even if the economy is declining
• ex. food and utility stocks

13
Stock Advisory Services

• A good supplement to information in newspapers
• Charge a fee
• Hundreds to choose from
• Standard and Poors reports
• Value Line
• Moodys Handbook of Common Stock
• On-line services allow access to web sites such
  as quote.yahoo.com and smartmoney.com

14
Numeric Measures to Consider When Evaluating a
Stock

• Look at book value of one share
• net worth of company divided by the number of
  outstanding shares
• if a share costs more than the book value the
  company may be overextended or it may have a lot
  of money in research and development

15
Numeric Measures to Consider When Evaluating a
Stock
(continued)

• Look at the price earnings ratio
• also called the P-E
• price of one share of stock divided by the
  earnings per share of stock over the last 12
  months
• a low number means could be a good time to buy
  it, however many technology stocks have high P-Es
• Look at the beta for the stock
• stock with a beta gt1.0 means more volatility

16
Earnings Per Share
Earnings Per Share are a corporations after-tax
income divided by the number of outstanding
shares Assume XYZ Corporation has after-tax
earnings of 2,500,000. Also assume that XYZ has
1,000,000 shares of common stock. This means
their Earnings per share would be 2.50
After-tax
income Earnings per share Number of shares
outstanding

2,500,000

1,000,000 2.50
17
Price-Earnings Ratio
The price of a share of stock divided by the
corporations earnings per share of stock. Using
the example in the last slide, the Earnings Per
Share were 2.50. Assume that XYZs stock is
selling for 50 per share. Their P/E Ratio would
be 20
Price per share Price-earnings (P/E)
ratio Earnings per share
50.00
2.50
20
18
Dividend Payout
Dividend payout is the percentage of a firms
earnings paid to stockholders in cash. Assume
Ford Motor Company paid out an annual dividend of
0.40 per share. Also assume Ford Motor Company
earned 1.44 share. The Dividend Payout would be
28
Dividend amount Dividend payout Earnings
per share
0.40 1.44
0.28 28
19
Current Yield
Current yield is the yearly dollar amount of
income generated by an investment divided by the
investments current market value. Assume Ford is
currently selling for 10 per share. The current
dividend yield is 4
Annual income amount Current yield
Market value
0.40 Current yield 10.00 0.04 or 4
20
Buying and Selling Stocks
Primary Market Initial Public Offering
(IPO) Secondary Market Security Exchange New
York Stock Exchange (NYSE) American Stock
Exchange (AMEX) Regional Stock Exchanges
(Chicago, San Francisco, Philadelphia, Boston,
etc.) Over-the-Counter Exchange NASDAQ
21
A Sample Stock Transaction
Market Order Day Order Week Order (Good This
Week, GTW) Month Order (Good This Month,
GTM) Limit Order Stop Order
22
Long-Term Investment Strategies
Buy-and-Hold Technique Dollar Cost
Averaging Value Cost Averaging
23
Direct Investment and Dividend Reinvestment Plans
Direct Investment Plan allows you to purchase
stock directly from a corporation without having
to use an account executive or a brokerage
firm. Dividend Reinvestment Plans (DRIP) allows
you the option to reinvest your cash dividends
back into your portfolio to purchase additional
shares of stock.