Chapter 11 Investing In Stocks

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Chapter 11Investing In Stocks
11-1
Kapoor Dlabay Hughes Ahmad
Prepared by Cyndi Hornby, Fanshawe College
? 2009 McGraw-Hill Ryerson Ltd.
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Learning Objectives Chapter 11
11-2

1. Identify the most important features of common
   stocks.
2. Discuss the most important features of preferred
   stock.
3. Explain how you can evaluate stock investments.
4. Describe how stocks are bought and sold.
5. Explain the trading techniques used by long-term
   investors and short-term speculators.

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Learning Objective 1Identify the most
important features of a common stock.
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How Are The Markets Doing?
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• Index a statistical measure of the changes in a
  portfolio of stocks representing a portion of the
  overall market.
• SP/TSX Composite Index
• Dow Jones Industrial Average
• NYSE Composite Index
• Nasdaq Composite Index
• Standard Poors 500 Stock Index

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Investing In Stocks
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• Public Corporations stocked trades openly in
  stock markets and may be purchased by individuals
• Private Corporations stocks are owned by
  relatively few people are not traded openly in
  stock markets
• Why do corporations issue common stock?
• To finance business start up costs and help pay
  for ongoing business activities
• A form of equity
• They dont have to repay the money.
• Price is determined by how much buyer willing to
  pay
• Dividends are not mandatory

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Investing In Stocks
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• Stockholders have voting rights and control of
  the company
• Proxy a legal form that lists the issues to be
  decided at a shareholders meeting and requests
  the shareholders to transfer their voting rights
  to another
• Pre-emptive Right the right of current
  shareholders to purchase any new stock the
  corporation issues before it is offered to the
  general public

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Why Do Investors Purchase Stock?
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• Income from dividends.
• Dollar appreciationof stock value.
• Possible increased value from stock splits (a
  procedure in which the shares of common stocks
  owned by existing shareholders are divided into a
  larger number of shares.

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Learning Objective 2Discuss the most
important features of preferred stocks.
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Preferred Stock
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• Receive cash dividends before common stock
  holders are paid any cash dividends.
• The dividend amount is either a stated amount of
  money for each share of preferred stock, or a
  percentage of the par value.
• Par value is an assigned dollar value that is
  printed on a stock certificate.
• First claim on corporations assets.

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Preferred Stock
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• Callable preferred stock is stock a corporation
  may exchange for a specified amount of money.
• After calling an issue, they can issue new
  preferred stock with a lower dividend.

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Features of Preferred Stock
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• Cumulative feature.
• Unpaid cash dividends accumulate and must be paid
  before any cash dividends are paid to the common
  stock holders.
• Participation feature.
• Rare form of investment used to attract
  investors.
• Can share in earnings beyond the stated dividend
  amount.
• Conversion feature.
• Can be traded for shares of common stock.

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Learning Objective 3Explain how you can
evaluate stock investments.
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Stock Valuation
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• Important to understand different approaches used
  by experts to analyze stocks
• Fundamental Analysis
• A way to value stocks by looking at micro and
  macro factors that might influence the economic
  value of stocks
• Technical Analysis
• The idea that changes in investor sentiment are
  responsible for changes in trends, and that the
  value of a stock can be predicted by
  extrapolating price from historical patterns
• Efficient Market Hypothesis
• States that future prices cannot be predicted
  from past trends and patterns

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Classification of Stock Investments
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• Blue chip stock.
• Safe investment in strong and respected
  companies.
• Attracts conservative investors.
• ex. Bell Canada, Royal Bank
• Income stock.
• Pays higher than average dividends.
• ex. utility stock.

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Classification of Stock Investments
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• Growth stock.
• Earns above average profits of all firms in the
  economy.
• Less than 30 of earnings are paid out as
  dividends, with rest reinvested in research
  development
• ex. Southwest Airlines, Home Depot
• Penny Stocks.
• Typically sell for less than 1 per share.

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Classification of Stock Investments
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• Cyclical stock.
• Follows the business cycle of advances and
  declines in the economy.
• ex. automobiles, timber, and steel.
• Defensive stock.
• Remains stable during declines in the economy.
• ex. Kellogg, Procter Gamble and utility stocks.

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Classification of Stock Investments
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• Large cap stocks.
• Issued by a large corporation that has a large
  amount of stock outstanding a large amount of
  capitalization.
• Capitalization.
• The total amount of securities--stocks and
  bonds--issued by a corporation.
• Small cap stocks.
• Issued by a company that has a capitalization of
  150 million or less.

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Sources of Information on Stocks
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• Newspapers
• The Internet
• Stock Advisory Services
• Charge a fee
• Hundreds to choose from
• Corporate News
• Disclose information about corporate earnings,
  assets and liabilities, products or services

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Factors that Influence the Price of Stocks
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• Bull market.
• Investors are optimistic about nations economy.
• More investors are buying stock and the stock
  market increases.
• Bear market.
• Investors are pessimistic about economy.
• More investors are selling stock so and the stock
  market declines.

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Measures of Corporate Risk, Performance and
Shareholders Return
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• Annual Shareholders Return
• A stocks annual dividend and increase in value
  divided by its beginning-of-year stock price

Annual Shareholder Annual Dividend
Appreciation in Value Return
Initial Stock Investment
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Measures of Corporate Risk, Performance and
Shareholders Return
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• Dividend Yield
• A stocks annual dividend divided by its
  beginning-of-year stock price
• If the dividend is divided by the end-of-year
  stock price, it is referred to as its trailing
  dividend yield

Annual Dividend Yield Annual Dividend
Initial Stock
Investment
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Measures of Corporate Risk, Performance and
Shareholders Returns
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• Capital Gains Yield
• A stocks increase in value divided by its
  beginning-of-year stock price

Capital Gains Yield Appreciation in Value
Initial Stock
Investment
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Measures of Corporate Risk, Performance and
Shareholders Returns
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• Earnings Per Share
• Are the corporations after tax-earnings divided
  by the number of outstanding shares of common
  stock

Earnings Per Share After-Tax
Earnings Number of outstanding shares
of common stock
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Measures of Corporate Risk, Performance and
Shareholders Returns
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• Price-Earnings (PE) Ratio
• Price of one share of stock divided by the
  earnings per share of stock over the past 12
  months
• A low price-earnings ratio means a stock could be
  a good investment

Price-Earnings Ratio Price Per Share
Earnings per share of stock
Outstanding over the last 12 months
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Measures of Corporate Risk, Performance and
Shareholders Returns
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• Beta
• Is an index that compares the risk associated
  with a specific stock issue with the risk of the
  stock market in general

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Learning Objective 4Describe how stocks are
bought and sold.
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Primary Market for Stocks
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• A market in which an investor purchases financial
  securities via an investment bank, or other
  representative, from the issuer of those
  securities.
• An investment bank is a financial firm that
  assists corporations in raising funds usually by
  helping to sell new security issues.
• An IPO occurs when a corporation sells stock to
  the general public for the first time.

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Secondary Market for Stocks
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• A market for existing financial securities that
  are currently traded among investors.
• A marketplace where member brokers who represent
  investors meet to buy and sell securities.
• The securities sold at an exchange must be
  listed, or accepted for trading, at the exchange.
• Toronto Stock Exchange or Canadian Venture
  Exchange

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Secondary Market for Stocks
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• The Over-the-Counter (OTC) market.
• Network of dealers who buy and sell the stocks of
  companies not listed on a securities exchange
  NASDAQ (an electronic marketplace)

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Brokerage Firms and Account Executives
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• An account executive, or stockbroker, is a
  licensed individual who buys and sells securities
  for his or her clients.
• Churning.
• Excessive buying and selling of securities to
  generate commissions.
• Discount broker versus full service
• brokers.
• Cost of research material
• Help in making decisions
• Ease of buying and selling

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Types of Stock Orders
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• A market order is a request to buy or sell stock
  at the current market value.
• A limit order is a request to buy or sell a stock
  at a specified price or price range.
• A stop order is a request to sell a stock at the
  next available opportunity after its market price
  reaches a specified amount.
• A discretionary order lets the account executive
  decide when to execute the transaction and at
  what price.

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Types of Stock Orders
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• Computerized transactions.
• Discount brokerage firms and some full services
  brokerage firms allow investors to trade online.
• It can make the process cheaper and faster.
• Commission charges.
• Wide range depending on the amount of service.
• Round lot is 100 shares or multiples of 100
  shares. An odd lot is fewer than 100 shares.

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Securities Regulation
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• To ensure full, true and plain disclosure of all
  facts by sellers of securities
• Provincial Regulation
• Registration
• Disclosure
• Enforcement
• Self Regulatory Organizations
• Are responsible for industry conformity with
  securities legislation

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Learning Objective 5Explain the trading
techniques used by long-term investors and
short-term speculators.
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Long-Term and Short-Term Investment Strategies
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• Long-term techniques
• Diversification
• Involves combining many assets in a portfolio to
  reduce the risk
• Buy and Hold technique
• Portfolio value increases through dividend
  payment, appreciation in stock value and dividend
  reinvestment

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Long-Term and Short-Term Investment Strategies
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• Long-term techniques
• Dollar cost averaging
• Investors purchase an equal dollar amount of the
  same stocks at equal intervals
• Direct investment and dividend reinvestment
• Purchase stocks directly from the corporation
• Reinvest dividends to purchase more stocks

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Long-Term and Short-Term Investment Strategies
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• Short-term techniques.
• Buying stock on margin
• borrowing money to buy a particular stock
• Selling short
• borrowing stock that must be replaced later
• Trading in options
• The right to buy or sell stocks at a
  predetermined price during a specified period of
  time

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Summary of Learning Objectives
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• Identify the most important features of common
  stocks
• Corporations sell stocks to
• Finance their start up costs
• Help pay for ongoing business activities
• People invest because of
• Dividend income, appreciation of value and gain
  through stock splits
• Dividend payments must be approved by the Board
  of Directors

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Summary of Learning Objectives
11-39

• Identify the most important features of common
  stocks
• Shareholders have right to elect Board and
  approve changes to corporate policy that include
• Amendment to corporate charter
• Sale of certain assets
• Possible mergers
• Issuance of preferred stocks or corporate bonds
• Changes in the amount of common stock

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Summary of Learning Objectives
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• Discuss the most important features of preferred
  stock
• Receive dividends before common shareholders
• May include extra features
• Cumulative feature
• Participation feature
• Conversion feature

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Summary of Learning Objectives
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• Explain how you can evaluate stock investments
• Information contained in newspaper or internet
• Be familiar with various measures of corporate
  and investment performance
• Typical psychological biases
• Two different analytical techniques used in stock
  selection
• Theory of efficient markets

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Summary of Learning Objectives
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• Describe how stocks are bought and sold
• New stock issues sold through investment bank or
  directly to current shareholders
• In secondary market through a securities exchange
  or over-the-counter market
• Most investments done through account executive
  or online
• Minimum commission charged for buying or selling
  stocks
• Additional commission charged based on
• Number and value of shares bought or sold
• Full service or discount broker or online
• Regulations in place to protect investors

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Summary of Learning Objectives
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• Explain the trading techniques used by long-term
  investors and short-term speculators
• Long term
• Hold investments for at least a year
• Build a diversified portfolio
• Buy-and-hold technique
• Dollar cost averaging
• Direct investment plans
• Dividend reinvestment plans

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Summary of Learning Objectives
11-44

• Explain the trading techniques used by long-term
  investors and short-term speculators
• Short Term
• Sell investments within short period of time
• Buy on margin
• Sell short
• Trade in options