Investing in Stocks

Purpose of Stocks

• Business perspectiveBusiness perspective– Raise fundsRaise funds

• Investor perspectiveInvestor perspective– Investment instrumentInvestment instrument– Short and long term earnings potentialShort and long term earnings potential– Barrier against inflationBarrier against inflation

Stocks Classification

• IncomeIncome– Consistent history of paying high dividendsConsistent history of paying high dividends– You buy the stock to keep a long time, You buy the stock to keep a long time,

expecting to make money through dividends expecting to make money through dividends (a share of the company’s profit)(a share of the company’s profit)

• GrowthGrowth– Most of company profits reinvested instead of Most of company profits reinvested instead of

distributeddistributed– You buy the stock to sell it later, expecting the You buy the stock to sell it later, expecting the

price per share to increaseprice per share to increase

Quality of Stocks

• New and small companies are less New and small companies are less establishedestablished– Future uncertainFuture uncertain– May be very profitableMay be very profitable

• Blue chip stocks – large companies that Blue chip stocks – large companies that have been aroundhave been around

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Capitalization

• CapitalizationCapitalization is the dollar market value of is the dollar market value of all of a company’s outstanding sharesall of a company’s outstanding shares

Shares outstanding Shares outstanding

X current market price per shareX current market price per share

• Large-cap (over $10 billion)Large-cap (over $10 billion)

• Mid-cap ($2 to 10 billion)Mid-cap ($2 to 10 billion)

• Small-cap (less than $2 billion)Small-cap (less than $2 billion)

Defensive vs. Cyclical

• Defensive stock – remains stable; pays Defensive stock – remains stable; pays dividends during economic declinedividends during economic decline– Utilities, drugs, food, health careUtilities, drugs, food, health care

• Cyclical stocks – profits fluctuate during Cyclical stocks – profits fluctuate during the year; do poorly during recessionsthe year; do poorly during recessions– Travel-related business (especially leisure Travel-related business (especially leisure

travel) travel)

How do stocks work?

• Company sells all of part of the value of Company sells all of part of the value of the business (assets)the business (assets)– Cash, machines, stock, vehicles, buildingsCash, machines, stock, vehicles, buildings

• Divide value into pieces Divide value into pieces – Each piece is a share of stock, or a share in Each piece is a share of stock, or a share in

the value of the companythe value of the company– People buy shares, often in blocksPeople buy shares, often in blocks

Where’s the profit?

• Company perspectiveCompany perspective– Get revenue they need without having to rely Get revenue they need without having to rely

in loansin loans– No interest paymentsNo interest payments

• Investor perspectiveInvestor perspective– Sell stocks later for a higher priceSell stocks later for a higher price– Get a share of the company’s profit through Get a share of the company’s profit through

dividendsdividends

Types of Stock Ownership

• Common stockCommon stock– Pays a variable dividend (based on how much Pays a variable dividend (based on how much

the company earns)the company earns)• Corporate earnings are divided by the number of Corporate earnings are divided by the number of

sharesshares• No profit means no dividendsNo profit means no dividends• Ex: If dividends per share = 50 cents, and you own Ex: If dividends per share = 50 cents, and you own

100 shares, you earn $50.100 shares, you earn $50.

– Voting rights (major policy decisions)Voting rights (major policy decisions)

Preferred Stock

• Pays a fixed dividend (stock holders are Pays a fixed dividend (stock holders are guaranteed a dividend check)guaranteed a dividend check)

• No voting rightsNo voting rights

What is stock worth?

• Par value – assigned dollar value printed Par value – assigned dollar value printed on a stock certificateon a stock certificate

• Market value – the current selling price at Market value – the current selling price at any given momentany given moment– What people are willing to payWhat people are willing to pay– Stock prices can be over or undervaluedStock prices can be over or undervalued

Stock prices are affected by …

• Financial health of the companyFinancial health of the company– Is it making a profit? How much debt?Is it making a profit? How much debt?

• Interest ratesInterest rates– When interest rates are lower than rate of When interest rates are lower than rate of

inflation, more people will invest in stocks; inflation, more people will invest in stocks; prices rise.prices rise.

• The market the company is in.The market the company is in.– Ex: technology, health services, travelEx: technology, health services, travel

• Earning per shareEarning per share– Profit – taxes and expenses Profit – taxes and expenses ÷ # ÷ # sharesshares

• Return on investment, or ROI, is the profit (or Return on investment, or ROI, is the profit (or loss) from buying and selling stocks (or any loss) from buying and selling stocks (or any investment).investment).

• To calculate ROI:To calculate ROI:

Why we invest … ROI!

= ROI___Current Profit on Stock__

Purchase Price + Commission

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Earnings per share (EPS)

• The portion of a company's profit allocated The portion of a company's profit allocated to each outstanding share of common to each outstanding share of common stock. Earnings per share serves as an stock. Earnings per share serves as an indicator of a company's profitability.indicator of a company's profitability.

= EPSNet Income – Preferred Stock Dividends Outstanding Shares of Common Stock

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Formula Review

= ROI___Current Profit on Stock__

Purchase Price + Commission

= EPSNet Income – Preferred Stock Dividends Outstanding Shares of Common Stock

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Questions?

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The Securities Market

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The Securities Market

• Where securities are bought and sold inWhere securities are bought and sold in– Securities exchange ORSecurities exchange OR– Over-the-counter-marketOver-the-counter-market

• You need a licensed You need a licensed trading agent trading agent to to buy and sell stocksbuy and sell stocks

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The Securities Exchange

• Securities = stocks and bondsSecurities = stocks and bonds

• Securities exchanges: where … Securities exchanges: where …

A marketplace where brokers who are representing investors meet to buy and sell securities

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Major Stock Exchanges

NYSE – the Big BoardNYSE – the Big Board

• Located at 11 Wall Street in NYCLocated at 11 Wall Street in NYC

• Largest stock exchange in the world by Largest stock exchange in the world by dollar volume and market valuedollar volume and market value

• Second largest by companies representedSecond largest by companies represented

• Trading floor is 2/3 size of football fieldTrading floor is 2/3 size of football field

• Hours 9:30 A.M. to 4:00 P.M.Hours 9:30 A.M. to 4:00 P.M.

Text page 339

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Major Stock Exchanges

AMEX (American Stock Exchange)AMEX (American Stock Exchange)

• Located at 86 Trinity Place, NYCLocated at 86 Trinity Place, NYC

TSE (Tokyo Stock Exchange)TSE (Tokyo Stock Exchange)

• Located Tokyo, JapanLocated Tokyo, Japan

• Second largest stock exchange in the Second largest stock exchange in the world by market valueworld by market value

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Over-the-Counter (OTC) Market

• A network of brokers buy and sell A network of brokers buy and sell securitiessecurities NOTNOT listed on a stock exchangelisted on a stock exchange

• Trade through telephones and computersTrade through telephones and computers

NASDAQ (National Association of Securities NASDAQ (National Association of Securities Dealers Automated Quotient)Dealers Automated Quotient)– Located everywhere electronicallyLocated everywhere electronically– Largest stock exchange by number of Largest stock exchange by number of

companies listedcompanies listed

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Market Cycles

• Bull MarketBull Market– Stocks prices rise over long period Stocks prices rise over long period

of timeof time– Investor optimismInvestor optimism

• Bear marketBear market– Stock prices fall over long period of timeStock prices fall over long period of time– Investor pessimismInvestor pessimism

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Investing Strategies

• Short-termShort-term– Buy on margin: Buy on margin:

• Share cost of stock with broker; buying stock on Share cost of stock with broker; buying stock on credit (leverage)credit (leverage)

• Investment dollars go fartherInvestment dollars go farther• Interest expense / greater riskInterest expense / greater risk

– Sell shortSell short• Selling stock you borrow from the brokerSelling stock you borrow from the broker• Make money if price of stock dropsMake money if price of stock drops

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Investing Strategies

• Long-termLong-term– Buy and holdBuy and hold

• Stock split: one share becomes two or moreStock split: one share becomes two or more• Dividend reinvestment: buy more shares instead of Dividend reinvestment: buy more shares instead of

taking the dividends as incometaking the dividends as income

– Dollar-cost averagingDollar-cost averaging• Spread stock purchase over timeSpread stock purchase over time

– Direct investmentDirect investment• Purchase stock directly from companyPurchase stock directly from company

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Questions?

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Reading the Stock Listings

• Sources:Sources:– Wall Street JournalWall Street Journal– Many places onlineMany places online

• Main columnsMain columns and and SMG siteSMG site

• See text Pg 347 for more examplesSee text Pg 347 for more examples

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Stock Indexes

• How investors measure / judge investment How investors measure / judge investment performance (How is the stock doing?)performance (How is the stock doing?)

• Dow Jones Industrial AverageDow Jones Industrial Average– 30 major stocks on the NYSE30 major stocks on the NYSE

• Standard and Poor’s 500 (S&P 500)Standard and Poor’s 500 (S&P 500)

• NASDAQ Composite IndexNASDAQ Composite Index

• Check on Check on YahooYahoo