INVESTING IN STOCKS

Money ManagementChapter 12 Notes

NEWS IMPACTING STOCK PRICES

BUYING STOCKS• According to our book, over

50,000 Americans own stock in more than 34,000 different publicly traded companies! – A public corporation is a company

whose stock is traded openly on stock markets like the NYSE or NASDAQ

• Stocks are traded in round lots or odd lots.– A round lot is 100 shares or

multiples of 100.– An odd lot is less than a 100 shares. – Brokerage Firms sometimes charge

more for odd lot purchases. This is because the firm will have to combine odd lot purchases to make a round lot purchase before they can submit the order!

COMMON STOCK• Common stock is a class of stock in which the

owner of the stock shares directly in the success or failure of a business.– As a shareholder you stand to profit when the

company profits. You also have some say in policy decisions like whether to issue more stock to outside buyers, changes on the board of directors etc…

– The more shares you own, the more say you have and the greater your power is.

– When the company does well, they will often pay Dividends: which are a portion of the profits that are redistributed to the shareholders of a corporation. Dividends are usually declared once a year.

– Common stockholders can lose all of their investment in a business if the stock bottoms out!

– Common stockholders are entitled to vote for the board of directors that runs the corporation.

• When you assign your right to vote to someone else that is known as a proxy.

PREFERRED STOCK

• In addition to common stock, investors can purchase preferred stock.– Dividends are fixed, regardless of how the

company does, making it less risky than common stock.

– In the event the company fails, preferred stockholders are paid first.

– The investor can only lose as much as they put in, no more!

– Preferred stockholders do not have voting privileges.

• How to Buy Preferred Stock: http://www.forbes.com/columnists/forbes/2003/0303/108.html

CLASSIFICATION OF STOCK INVESTMENTS

• How do you decide what type of stock to buy?

• To make analysis a bit more organized, analysts use a few classifications:

INCOME VS. GROWTH STOCKS

• Stocks that have a consistent history of paying high dividends are known as income stocks. – Preferred stocks are usually the investors

choice if they are after income stocks.• Growth stocks are companies that

REINVEST their profits into the business so that they can grow and expand.– In the long run, ten or twenty years, these

types of companies may be worth substantially more than their purchase price today.

– Growth stocks usually pay little or no dividend.

PENNY VS. BLUE CHIP STOCKS

• When a stock sells for less than $5 per share it is classified as a penny stock.– Although inexpensive, penny stocks are considered

highly speculative. – In other words, they can grow substantially or lose all

their value.– Frequently these stocks are issued by companies

with a “hot” new product that may be an enormous long-term success or merely a fad!

• Blue Chip Stocks are stocks of large well-established, and usually profitable businesses. – Most people have heard of these companies because

their products have been around for decades. – Companies like McDonald’s, Coca-Cola, Microsoft,

and Ford Motor Company are examples.

Defensive vs. Cyclical Stocks

• A defensive stock is one that remains stable and pays dividends during an economic decline. – Generally, companies in this category have a history of

stable earnings. – A defensive stock is not as subject to the ups and downs

of business cycles. – The demand for their products is consistent regardless of

economic conditions.– Examples include: Food, Utilities, and Health Care

industries

• Cyclical stocks do well when the economy is stable or growing, but do very poorly during recessions.– Examples are airline companies and other industries

based on traveling – people may feel like they can’t afford an expensive vacation.

Stock Values and Return on Investment

• When you buy a stock you will pay its market value. – Market Value reflects the price investors are

willing to pay for a share at that moment.– How a company is doing, its track record, and

how well it is expected to do in the future will determine market value.

– Stocks can be considered “overvalued” or “undervalued” if they are selling for a price that is not justified by their earnings potential.

– You can use ratios such as Earnings per Share (EPS) and the Price/Earnings Ratio (P/E) to determine if a stock is under or overvalued.

How do you make money buying stock?

• There are two major ways:– Stock can increase in value through

market activity.– Dividends can be paid – usually in the

form of cash or extra shares.

• The return on investment is how much money you make from the investment. It is the difference between what you paid for the stock and what you sold it for, plus any dividends you earned!

• ROI is computed as follows: Current Price + Dividends Purchase Price + Commission- 1 * 100

Securities Market

• A securities market is where you buy and sell securities – which are stocks and bonds.

• A securities exchange is a marketplace where brokers who are representing investors meet to buy and sell securities.– The largest organized

exchange in the U.S. is the New York Stock Exchange (NYSE)

– Watching it at work is truly an experience!

HOW THE NYSE WORKS…• The trading floor is almost as big as a football field• Floor brokers buy and sell stocks on the floor.

Only brokers who are members of the exchange may trade there.

• Trading posts are spread out about every 100 feet. All buying and selling is done at these trading posts.

• About ninety stocks are assigned to each post.• Orders received at a brokerage firm are sent by

computer’s to that firm’s booth at the exchange. • A message is printed out & given to the floor broker• When the trade is complete, the floor broker

reports back to their brokerage firms. • The buyer and seller can be notified that the

transaction has been concluded.• Stock trading is done auction style … meaning for

every transaction, the highest bidder meets the lowest seller.

• The NYSE is open from 9:30 am - 4:00 pm each day.

Over-the-Counter-Market• When securities are bought and sold

through brokers, but not through a stock exchange, the transaction is over-the-counter (OTC).

• The OTC market is a network of brokers who buy and sell securities of corporations who are not listed on the exchanges.

• Brokers in the OTC market DO NOT deal face-to-face. Trades are done via phone or computer only.

• NASDAQ is the largest OTC Market.• To be listed with them the company

must have at least 100,000 shares of stock worth at least 1 million.

INVESTMENT STRATEGIES

• Once stock has been acquired, your investment may be either short or long term.– Generally, if you buy and

sell stock within a short period of time, you are considered a speculator, or trader.

– If you hold your investments for a long period of time (a year or more), you are considered an investor.

Short-Term Strategy

• Selling short – strategy used if you feel like a stock price is going to drop!– To sell short, you borrow a certain number of

shares from a broker.– You then sell them at the current price and

hold on to the cash. – Once the price has dropped, you buy back the

correct number of shares at the lower price. This is called “covering your short position”.

– You then return the correct number of shares to the broker and keep the extra money!

Long-Term Techniques

• As you may have already learned, investing in the stock market for the short-term is highly speculative and extremely risky.

• Most advisors recommend long-term investment strategies instead. That’s how to make the stock market work for you!

• The most popular long-term investment strategy is the Buy and Hold.– Pick solid companies with great growth and

earnings potential and HOLD on to the stock! Collect your dividends and watch your portfolio grow!

Stock Splits• Stock splits can also add to your investment. • A stock split occurs when a company increases

the number of shares it has outstanding, but lowers the selling price in direct proportion.– For example: Lets say Google believes that it’s

stock is getting too expensive. They want the price to be cut in half. So they execute a two to one (2:1) stock split.

• If you owned 100 shares of Google worth $400 per share for a total of $40,000 – you would now own 200 shares worth $200 per share for a total of $40,000. Looks the same right?

• This stock split lowers the cost of the stock and will hopefully encourage more people to buy the stock! But now if the price goes back up to $400 again … you own twice as many shares! That’s a pretty great deal!