Chapter. Investing in Stocks Evaluating Stocks 12.2 Buying and Selling Stock South-Western, Cengage Learning

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1 Chapter 12 Investing in Stocks 12.1 Evaluating Stocks 12.2 Buying and Selling Stock 2010 South-Western, Cengage Learning

2 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 South-Western, Cengage Learning SLIDE 3

3 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 South-Western, Cengage Learning SLIDE 4

4 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 South-Western, Cengage Learning SLIDE 5

5 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 2010 South-Western, Cengage Learning SLIDE 6

6 Types of Stock Investments Income stocks Growth stocks Emerging stocks Blue chip stocks Defensive stocks Cyclical stocks 2010 South-Western, Cengage Learning SLIDE 7

7 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 2010 South-Western, Cengage Learning SLIDE 8

8 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 South-Western, Cengage Learning SLIDE 9

9 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 South-Western, Cengage Learning SLIDE 10

10 Blue chip stocks are stocks of large, wellestablished 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 2010 South-Western, Cengage Learning SLIDE 11

11 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 South-Western, Cengage Learning SLIDE 12

12 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 South-Western, Cengage Learning SLIDE 13

13 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 South-Western, Cengage Learning SLIDE 14

14 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 South-Western, Cengage Learning SLIDE 15

15 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 2010 South-Western, Cengage Learning SLIDE 16

16 Commonly used indexes include: Dow Jones Industrial Average (30 largest US companies large cap; leading indicator of market health) Nov ,000 had never been higher Jan ,400 Feb ,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) 2010 South-Western, Cengage Learning SLIDE 17

17 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 South-Western, Cengage Learning SLIDE 19

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19 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 2010 South-Western, Cengage Learning SLIDE 21

20 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 2010 South-Western, Cengage Learning SLIDE 22

21 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 2010 South-Western, Cengage Learning SLIDE 23

22 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 South-Western, Cengage Learning SLIDE 24

23 Example You have $2,000 in your margin account You wan to buy 100 $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 2010 South-Western, Cengage Learning SLIDE 25

24 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 South-Western, Cengage Learning SLIDE 26

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26 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 South-Western, Cengage Learning SLIDE 28

27 You have just return the stock shares 100, 200, 300 NOT the price per share!!! 2010 South-Western, Cengage Learning SLIDE 29

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29 Long-Term Investing Techniques Buy and hold Dollar-cost averaging Direct investment Reinvesting dividends 2010 South-Western, Cengage Learning SLIDE 31

30 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 South-Western, Cengage Learning SLIDE 32

31 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 South-Western, Cengage Learning SLIDE 34

32 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 South-Western, Cengage Learning SLIDE 35

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34 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 South-Western, Cengage Learning SLIDE 37

35 Reading the Stock Listings Excerpt from stock exchange listings: High 52 Wks Low Stock Div Yld% P/E Ratio Sales 100s High Low Close Net Change Enger Eng pf Entld Epsco Exlab z ExeB PG 275 Yld% -- want high and P/E ratio want high 2010 South-Western, Cengage Learning SLIDE 38

36 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 $ South-Western, Cengage Learning SLIDE 39

37 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 2010 South-Western, Cengage Learning SLIDE 40

38 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 South-Western, Cengage Learning SLIDE 41