© South-Western Educational Publishing Chapter 12 Investing in Stocks Evaluating Stocks Buying and...

© South-Western Educational Publishing

Chapter 12

Investing in Stocks

Evaluating StocksBuying and Selling Stock


GOALSGOALS

INVESTING IN STOCKS

Chapter 12


Terms to Know

StockholdersDividendsCapital gainCommon stockProxyPreferred stockIncome stocksGrowth stocksBlue chip stocks

Par valueMarket valueEarnings per shareBull marketBear marketLeverageShort sellingStock splitDirect investment Dividend reinvestment


Why Learn About Stocks

The stock market is the core of America’s economic system

Stock is a share of ownership in the assets and earnings of a companyBond is a type of debt that a company issues to investors for a specified amount of time.Stock market is a general term used to describe all transactions involving the buying and selling of stocks and bonds issued by a company


Why Companies Issue Stock

When a company would like to grow, it issues stocks to raise funds and pay for

ongoing business activitiesIt is popular because:

The company does not have to repay the moneyPaying dividends is optional

Dividends are distributions of earnings paid to stockholders


Risk vs. Return

On average, stocks have a high rate of return

The increase or decrease in the original purchase price of an investment

Higher rate of return = greater riskUncertainty about the outcome of an investment

Stocks provide portfolio diversificationMoney invested in a variety of investment tools


Investing


Why invest in stocks??


Characteristics of Stock12.1

CLOSED CORPORATION vs. PUBLIC CORPORATION

A Closed Corporation is formed the same as a regular corporation, except that the shareholders determine that they want to run the corporation without a Board of Directors. This decisions must be unanimous


Closed Corporation vs. Public Corporation

A Public Corporation is a company whose stock is traded openly on stock markets


Stockholders

Another name ShareholdersShareholders

What does it mean to be a stockholder?

You OWN a part of the company !!


HOW DO I BUY STOCK?

Yahoo Finance


Stock

Obtain a price for one (1) share of Old Navy stock


Gap subsidiaries: Banana Republic Old Navy Piperlime Athleta


Price for Berkshire Hathaway BRKa per share?


Stock Selection – please return to your seats for instructions & demo!


GOALSGOALS

Lesson 12.1

Evaluating Stocks

Describe the features of common stock and compare it to preferred stock.Discuss stock investing classifications and why you would choose one over another.Explain how stock values are determined.Discuss factors that affect a stock’s price.


Stock

Stockholder - part owner of companyDividend – portion of corporation’s profits that are paid to stockholders Capital gain – selling stock for more than you paid for itPrice goes down? Capital Loss


Stock

How much can a stockholder lose?as much as he/she had invested

Traded in: ROUND LOTS – (100 shrs.)ODD LOTS – (fewer than

100 shrs.)60/40 – 2 transactions


There are two types of stock:

CommonPreferred


Common Stock

Variable dividendVoting rights -

elect Board of Directors (decides to give shareholders Dividends)

- issue additional stock, sell company, change Board of Directors1 share = 1 voteProxy – stockholder’s written authorization to transfer his/her voting rights to someone else (company mgr.)


Buy Stocks

Price X # of shares = Total Cost

+ commission


Return on Investment

Profit / Original Investment X 100

Best way to measure your return!

Dollar amount not important – it’s the percentagepercentage that counts!!!


Dividends

A portion of the company’s profit that is paid to shareholders

Company sells ---- 10,000. {sales} --pays Expenses 7,500 {bills} --pays Taxes 500NET INCOME ----------2,000 {left over}


Dividends

Net Income $2,000.

3 Options: a) Retain and investb) Pay dividends to shareholdersC) Retain portion + pay out portion

Must a company pay out dividends?

No -- only if they choose to do so


Dividends

Who decides whether or not to pay dividends?

Company Board of Directors

Does a shareholder pay taxes on dividends?

Yes, both Federal & State


Dividends

When are dividends usually paid?

usually Quarterly (but can be annual)

Are dividends always paid in the form of cash?

No {Cash or additional Stock}


Important Dividend Dates

TRADE Date - Day on which the trade is executed

Declaration Date – Day on which a corporation’s board of directors meets, decides on the amount of the dividend, and makes the public announcement

Ex-Dividend Date -

Normally set for stocks TWO business days before the record date

If you purchase a stock ON its ex-dividend date OR AFTER, you will NOT receive the next dividend payment

Purchase before the ex-dividend date, you get the dividend


Dividend Dates

Record Date – Date established by an issuer of a security for the purpose of determining the holders who are entitled to receive a dividend or distribution

Payment Date - Day on which the corporation makes payment of the dividend to previously determined holders of record


Dividend Dates – cont.

SUN MON TUES WED THURS FRI SAT1 2 3 4 5 6 78 9 10 11 12 13 1415 16 17 18 19 20 2122 23 24 25 26 27 2829 30

Here is an example:Declaration Date Ex-Dividend Date Record Date Payable Date 7/27/99 8/6/99 8/10/99 9/10/99

On July 27, 1999, Company XYZ declares a dividend payable on September 10, 1999 to its shareholders.


XYZ also announces that shareholders of record on the company's books on or before August 10, 1999 are entitled to the dividend. The stock would then go ex-dividend two business days before the record date.

Excluding weekends and holidays, the ex-dividend is set two business days before the record date or the opening of the market

in this case on the preceding Friday.

This means anyone who bought the stock on Friday or after would not get the dividend.

At the same time, those who purchase before the ex-dividend date receive the dividend.


Example of ….

CRUCIBLE DECLARES BIG STOCK DIVIDEND; Announcement of 50 Per Cent. Payment First Since Decision as to its Non-Taxability. PAR VALUE IS $12,500,000 Stanley Works of New Britain to Issue 100 Per Cent. Stock Bonus and Buy Level Company.

PITTSBURGH, Pa., March 16.--Di rectors of the Crucible Steel Company of America late today declared a stock dividend of 50 per cent., payable in the common stock of the company on April 30 to stockholders of record April 15. It is the first important corporation to take such action since the decision of the United States Supreme Court affecting stock dividends.


How Stocks are Traded

Stock Trades


Types of Stock Orders

MARKET ORDER LIMIT ORDER STOP LOSS ORDER / STOP STOP LIMIT ORDER

DAY ORDER GTC ORDER


MARKET ORDER

Order to buy/sell stock at the best possible price a/k/a current priceRisk in a Market Order?

actual price at which your trade will be executed - unknown


MARKET ORDER

What might change the price?

-- price moving quickly (volatile)

-- placing orders when market is closed


LIMIT ORDER

Order to buy/sell stock at a specified price, or better


LIMIT BUY ORDER

100 SHARES @ $13.50

Trade will execute at a price equal to or LESS than

= < $13.50/share


LIMIT SELL ORDER

100 SHARES @ $31.60

Trade will execute at a price equal to or GREATER than

= > $31.60/share


LIMIT DAY ORDER

Execute buy/sell order some time during that trading day

No execution order is automatically cancelled


GTC (Good’til Cancelled)

Order stands until it is filled or until investor cancels it

Broker policy – may automatically cancel GTC orders after 60/90 days-- may or may not renew a cancelled GTC order for you



Review Orders

Market Order – will execute (exact price unknown)

Limit Order – may not execute (exact price known)


Review Orders

You place a GTC limit order to sell 100 shares of Kmart at $7.50. Over the next two months, the price of KM ranges from a high of $8.10 to a low of $6.25.

Did your order execute?


Review Orders

Probably - possibility exists that you may place a limit order and the market may reach the limit price but your order was not executed.

stand in line


Protecting a profit –or- Limiting a loss

STOP LOSS ORDER


STOP LOSS ORDER

Order to sell a stock at the market price if the price falls to the requested stop loss price

-- place order, stop loss price should be below the current market price


STOP LOSS ORDER

-- if the value of the stock declines to the stop loss price, the stop loss order converts to a market order

-- hence, the actual value of the stock at execution may be less than or more than the requested stop loss price


STOP LOSS ORDER

i.e. Stock price = $31.75

Stop loss order = $25.

Stock falls to $22.50-- converted to market order at $25.-- may execute at $25 or lower


STOP LIMIT ORDER

Order to sell your shares at a specified price if the market falls to that price

-- place order, should be less than current market price

-- guarantees price, not execution


Types of Stock Orders - Summary

Buying Selling

Market - order to buy at the next available price

- order to sell at the next available price

Limit - order to buy at or below a specified price

- order to sell at or above a specified

price

Stop - order to buy above the current price

- order to sell below the current price

Stop Limit - order to buy above the current price with a limit

- order to sell below the current price

with a limit


Good-Till-Cancel order to buy 500 shares of MSFT on a stop at $51.00

Good-Till-Cancel order to buy 50 shares of MSFT at the limit price of $51.00

Day order to buy 500 shares of MSFT on a stop at $51.00 with a limit of $51.00

Good-Till-Cancel order to buy 500 shares of MSFT at the limit price of $51.00

Good-Till-Cancel order to sell 500 shares of MSFT at the limit price of $51.00

Which one describes this order???


Bid / Ask Prices

The bid is the price that someone is willing to pay for the stock you are selling. The ask is the price that someone is willing to sell to you the stock that you are interested in buying.


Bid / Ask Prices

Here's what the bid and ask look for MSFT recently:



Bid / Ask Prices

The bid/ask spread is simply the difference between those two prices. Typically the asking price will be higher than the bidding price.


Preferred Stock

Fixed dividend – less risky than common (less return)No voting rightsPreferred stock is often purchased by corporations because of tax breaks they offer companies


Classifying Stock Investments

Income versus growth stocksPay dividends /or/ reinvest in corp.Stocks that have a consistent history of paying high dividends Income stocks

Preferred stocks – most certain & predictable dividend incomeDoes not grow in value (price increase) as quickly as growth stocks



Growth Stocks – corporations that reinvest profits back into the business

looking for future price increases (capital gains)

Less-established versus blue chip stocksSmall corporations = higher risk / inexpensiveBlue Chip – large, well-established companies; solid record of profitability

safe, stable, but moderate returns



Defensive versus cyclical stocksDefensive – remains stable and pays dividends during economic declinesCyclical – increases when economy is prospering; poor performance during recessions


Defensive Stocks

Beverages (soft drinks and alcohol)

Consumer products (soaps, toothpaste, toilet paper, cleaning materials)

Drugs

Food

Gold

Health care

Pet care & food

Utilities, both electric and natural gas


Cyclical Stocks

Automobile manufacturersAirlinesFurnitureSteelPaperHeavy machineryHotelExpensive restaurants

--are the best examples.


GOALSGOALSMargin Buying


What is “Buying on Margin?”

Buying stock on credit

Margin increases your b u y i n g power.


A P P L Y

You must sign a “Margin Agreement” with your broker.

You must be “Approved” to Buy on Margin”


When you buy on margin, how much of the purchase price must you put up?

Initially --- 50%50% 50%50% 50%


Who determines the percentage?

The Federal Reserve Bank

a/k/a The “FED” Skip to


Why do you think there is a limit on the amount of money that brokers can lend?

If brokers lend too much money, losses could be greatHigh losses on margin accounts were one reason the stock market crashed in 1929Stock owners received margin callmargin call and could not meet them


Who’s Calling?Did You Know?

If a customer can’t provide additional cash, a broker can sell shares in the account, even without the knowledge or consent of the customer.

If other stocks are in the account, the broker may sell these shares in place of, or in addition to, the shares of the falling stock.


R I S KThink a 50% loss is bad?

It can get much worse. Buying on margin is the only stock-based investment where you stand to lose more money than you invested. A dive of 50% or more will cause you to lose more than 100%, with interest and commissions on top of that.


What are the advantages of buying stock on margin?An investor can buy MORE stock and make HIGHER returns


What are the disadvantages of buying stock on margin?

Stock purchases must pay interest on the loan, and if the stock goes down, their losses would be higher


The amount of collateral that

investors must deposit to open a

margin account – initial margin

requirement

Must be 50% (one-half) of the total

value of stock purchased/sold short


Initial Margin Requirement

To make a $10,000 stock purchase on margin

Investor must deposit $5,000

(5,000 / 10,000 X 100) = 50%


E Q U I T Y

Actual amount of ownership the

investor has in the account

Portion investor O W N S


ExampleCurrent value of stock purchased $10,000

Debt (money owed to Broker) - 5,000

EQUITY (amount owned by investor) $

5,000


Price of stock increasesCurrent value of stock $11,000

Debt (money owed to Broker - 5,000

EQUITY (amount owned by investor) $ 6,000

Equity also increases


Price of stock decreasesCurrent value of stock $9,000


EQUITY (amount owned by investor) $ ?

Equity also ?????


Price of stock decreasesCurrent value of stock $9,000


EQUITY (amount owned by investor) $4,000

Equity also decreases



Why use Margin?

LEVERAGE -- The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment

Leverage amplifies every point that a stock goes up. If you pick the right investment, margin can dramatically increase your profit.


Ticker

A worldwide electronic system that continuously shows the price and volume of a stock as it is traded.


Stock Index

Statistical gauge that uses a given number of stocks to measure changes in the overall stock market


MOVIE MARGIN


MARGIN OF SAFETY

An amount beyond the minimum necessary


DOW Jones Industrial Average

Formula based on the stock prices of 30 industrial companies Formula adds up the stocks’ prices and the divides by a certain number to derive the averageThe DowDow Jones Industrial Average is a key barometer of U.S. equities that is recognized and used the world over.


DOW

Price-weighted - company’s weight or importance depends upon “price’

i.e. 1% change in a high-priced stock has larger impact than a 1% increase in a lower-priced stock


United Technologies Corp.International Business Machines Corp.3M Co.Caterpillar Inc.American International Group Inc.Johnson & JohnsonProcter & Gamble Co.Boeing Co.Wal-Mart Stores Inc.American Express Co.Altria Group Inc.Citigroup Inc.Exxon Mobil Corp.Merck & Co. Inc.Coca-Cola Co.E.I. DuPont de Nemours & Co.General Motors Corp.Verizon Communications Inc.JPMorgan Chase & Co.Home Depot Inc.Honeywell International Inc.General Electric Co.Alcoa Inc.Pfizer Inc.McDonald's Corp.Microsoft Corp.SBC Communications Inc.Walt Disney Co.Intel Corp.Hewlett-Packard Co.


Stock Index

Statistical gauge that uses a given number of stocks to measure changes in the overall stock market


NASDAQ Composite Index (^IXIC)

Nearly 4,000 companies listed on NASDAQ Stock Market

Popular gauge for technology stocks


Russell 2000 Index

Gauge of smaller companies

Of 3,000 U.S. largest companies, the smallest 2,000 represent the Russell 2000


S & P 500 (GSPC)

Popular measure of stock prices consisting of 500 large companies that represent the major sectors of the U.S. economyValue-weighted - weight or importance of each company depends upon its market cap ( outstanding shares X price)


DOW vs S & P 500


Auction Market

Buyers and sellers interacting by announcing bids and offers and thereby determining prices, usually at a physical location like a trading floorNYSE (New York Stock Exchange) – largest, oldest, and most widely-knownHours 9:30 a.m. to 4:00 p.m.


NYSE - Auction

Specialist – watches over assigned stocks at a specific trading post


NASDAQNational Association of Securities Dealers Automated Quotation

Computerized market that relies on Market Makers not a physical place


OTC – Over The Counter

An electronic quotation system for many stocks that don't qualify for listing on the national markets.BB Bulletin Board


Market Maker

A business that stands ready to buy or sell stock at publicly quoted prices

Keeps an inventory of stock (like a shoe store)

Investors deal directly with market makers, not other investors


Market Maker

Always quotes a Bid / Ask price and the number of shares it stands ready to buy or sell at those prices


AMEX

American Stock Exchange The third largest stock market in the U.S., with a trading floor in New York City where people trade stocks and other investments on behalf of investors.


The Securities Market

Securities exchanges –marketplace where brokers who are representing investor meet to buy and sell securities

largest organization in US NYSE (2/3rd size of football field) – AUCTION MARKET

Floorbrokers buy and sell on the exchangeTrading posts – specialists

American Stock Exchange




Www.marketrac.nyse.com


Large-Cap Stock

Companies whose market capitalization is large ($$$$$)

$5 Billion or more

IBM Market Cap: 200.63B


Small-Cap Stock

Companies whose market capitalization is small ($$)

Under $500 Million

1-800-Flowers.com Market Cap: 454.74M


Bull and Bear Markets


What is Market Capitalization (Market Cap)?


Total current market value of all outstanding shares of a company

-- $ Stock Price X # of outstanding shares


Determining a Stock’s Worth

Stock valuePar value – artificial dollar valueMarket value – price on current market

Stock priceStocks that are selling for “less” than what they are really worth – “undervalued”“Overvalued” – high risk of price decreases

Return on investment


Stock Price

The company – performance / earnings / debt statusInterest rates – as interest rates fall, people tend to invest moreThe market – demand determines profitabilityEarnings per share – after-tax earnings divided by the number of common stock shares outstanding (in hands of investors)


Stock Price

Net Profit = $1,000,000Outstanding = 100,000

$1,000,000 / 100,000 = $10/EPSstock probably sells for higher price

Measure of company’s profitability



What is Short Selling

Short selling is the sale of stock borrowed from a broker

It is a strategy often used when a buyer believes a particular stock will go down in value.


Short Selling

A short seller believes a particular stock’s price will drop and enable him/her to repay the borrowed shares with lower-priced ones.

The difference in the price between when the stock was borrowed from the broker and when it was repaid would be the short seller’s gain.


If the stock’s price rises, however, a short-seller will lose money because the borrowed shares will be repaid with higher-priced ones.


Example

if an investor borrows 100 shares of a particular stock from a broker at $10.00 a share , selling it on the market at that price, the investor sees the stock drop to $5.00 a share and buys the 100 shares from the market to repay the broker making a $5.00 per share profit.


This can be a risky transaction; if the shares go up to $15.00 per share the investor will lose $5.00 per share and needs to use cash to buy back the shares.


When a particular stock or the market in general (bear market) is declining, the opportunity to sell before buying or short sell gives investors a chance to realize gains on declining stocks.

Sell-high, buy-low strategy





Should the stock rise in price the loss potential is unlimited.

Many financial advisors, therefore, recommend short selling only to experienced investors.





Short Cover

Buying stock in order to repay a broker for the shares borrowed when the stock was sold short.


Long Position

The condition of owning stock. The value of a long position is a stock’s current share price multiplied by the number of shares owned.


GOALSGOALS

Short Selling


What is Short Selling

Short selling is the sale of stock borrowed from a broker

It is a strategy often used when a buyer believes a particular stock will go down in value.


Short Selling

A short seller believes a particular stock’s price will drop and enable him/her to repay the borrowed shares with lower-priced ones.

The difference in the price between when the stock was borrowed from the broker and when it was repaid would be the short seller’s gain.


If the stock’s price rises, however, a short-seller will lose money because the borrowed shares will be repaid with higher-priced ones.


Example

if an investor borrows 100 shares of a particular stock from a broker at $10.00 a share , selling it on the market at that price, the investor sees the stock drop to $5.00 a share and buys the 100 shares from the market to repay the broker making a $5.00 per share profit.


This can be a risky transaction; if the shares go up to $15.00 per share the investor will lose $5.00 per share and needs to use cash to buy back the shares.








Short Cover

Buying stock in order to repay a broker for the shares borrowed when the stock was sold short.


Long Position

The condition of owning stock. The value of a long position is a stock’s current share price multiplied by the number of shares owned.


GOALSGOALS

Lesson 12.2

Buying and Selling Stock

Describe market channels and the process for buying and selling securities.Describe short- and long-term investment strategies when buying and selling stocks.Explain how to read the stock listings in financial publications and how to use stock indexes.


A member firm is a company or individual who owns or

leases a "seatseat" on the NYSE. Only member firms are allowed to buy and sell securities on the trading floor. To become a member firm, a company must meet rigorous professional standards set by the Exchange. The number of seats has remained constant, at 1,366, since 1953.


The Securities Market

Over-the-counter market – securities bought and sold through broker but not through a stock exchange, the transaction is over-the-counter OTCNetwork of brokers who buy/sell securities of corporations that are not listed on a securities exchangeBrokers operating in the OTC market use an electronic quotation system called NASDAQ


Investing Strategies

Short-term techniques – buying on margin & Short selling

Speculator/Day Trader - buying stock for the short-term

Long-term techniques- Buy and hold

Investor - buying stock for the long-term


Short-Term Investing Techniques

Buy on marginLeverage - the use of borrowed money to buy securities

anticipate stock price

Margin call - market value of margined stock falls to one-half of the original purchase price

Sell short - selling stock borrowed from a broker


Long-Term Investing Techniques

Buy and holdRide out down timesDividendsStock split - increase in number of outstanding shares of company’s stock


Dollar Cost Averaging

Buy same stock with same amount of money at regular intervals

Month 1 - $400 ($20) Avg. Price = $10.43Month 2 - $400 ($10)Month 3 - $400 ($5) Purchase = $2,400Month 4 - $400 ($16) Sold = 3,680Month 5 - $400 ($10)Month 6 - $400 ($16) Profit = 1,280 or-- decide to sell 53%


Long-Term Investing Techniques

Dollar-cost averaging - systematic purchase of an equal dollar amount of the same stock at regular intervalsDirect investment - buy stock directly from companyReinvesting dividends

avoids broker fees & other costs


Reading the Stock Listings

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 -.5045.00 23.00 Eng pf 2.25 8.9 10 25 26.25 24.00 25.83 +.3810.50 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


Stock Progress Chart

Enger 28 28.50 29 29.50 30 + 2Glastn 40 39 38 38 38 - 2Karbr pf 61 62 62.38 61 61.13 + 0.13Maxln 51 51.13 52 52 53.50 + 2.5Totlmb 10.88 10 9 8 8.5 - 2.38

TotalStock ChangeNames 1 2 3 4 5 (+ or -)

Closing Prices for 10 days


Stock Indexes

Dow Jones Industrial AverageStandard & Poor’s 500NASDAQ Composite Index


Stock Splits

2:1 - Quantity of shares increase while price divides.

1 share @ 100 2:1 split ($100)2 share @ 50 ($100)


Bull and Bear Markets

Bull – prolonged period of rising stock prices

Bear – prolonged period of falling stock prices and a general feeling of investor pessimism


Bid / Ask Prices

Spread – difference between Bid and Ask price

Large difference means stock is volatile (risky; price changes often)


Annual Report

Annual reports are intended to give shareholders and other interested people information about the company's activities and financial performance.


Annual Report contents


Shareholder’s letter (written by CEO) – positive natureAuditor’s ReportMission Statement


Corporations

Must disclose financialfinancial information if they are PUBLIC.


Incorporation

Elect a Board of Directors


Steps to Incorporate

The articles of incorporation (also called a charter, certificate of incorporation or letters patent) are filed with the appropriate state office, listing the purpose of the corporation, its principal place of business and the number and type of shares of stock.



Authorize the number of shares of stock a company can issue.



Bylaws – outline of company meetings and rules and regulations by which the company will be governed.Must be filed with the STATE.


Stock Screener


Annual Report

Company is required by the SEC (Securities Exchange Commission) to hold an annual meeting + publish an annual report.

Also known as: 10KChanges in a fiscal year: 8K

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