Trading Strategies

1

• Trading Strategies
• (Picking the Equity Players, chapter 9 in
  Strong)

2
Stock Selection Philosophy

• Fundamental analysis
• Technical analysis

3
Fundamental Analysis

• A fundamental analyst tries to discern the
  logical worth of a security based on its
  anticipated earnings stream
• The fundamental analyst considers
• Financial statements
• Industry conditions
• Prospects for the economy
• Etc.

4
Technical Analysis

• A technical analyst attempts to predict the
  supply and demand for a stock by observing the
  past series of stock prices
• Financial statements and market conditions are of
  secondary importance to the technical analyst

5
Types of Dividends

• Cash dividends
• Stock dividends
• Spin-offs
• Rights

6
Cash Dividends

• Cash dividends are distributions of the firms
  profits to the shareholders paid via a check from
  the company
• Cash dividends can sometimes be reinvested via
  dividend reinvestment plans (DRIPs)
• Sometimes allow for purchase of additional
  company shares at a discount
• If shares are held in street name
• The brokerage firm receives the dividend check
• The brokerage firm ultimately allocates dividends
  to the shareholders

7
Stock Dividends

• Stock dividends are paid in additional shares of
  stock rather than in cash
• Typically announced as a percentage
• E.g., 10 percent stock dividends
• Popular when a firm lacks the funds to pay a cash
  dividend
• Popular early in the firms life cycle

8
Spin-Offs

• In a spin-off, a parent firm divests itself of a
  subsidiary and distributes all shares in the
  subsidiary proportionally to the parent firms
  shareholders
• The parent gives away the subsidiary

9
Rights

• The preemptive right means shareholders have the
  ability to maintain the same percentage share of
  ownership in a corporation when the firm sells
  new shares
• Existing shareholders can buy new stock at a
  discount from market price
• Rights are actual securities that shareholders
  can buy or sell
• Rights have a limited life
• Usually expire a few weeks after issued

10
Chronology of Events

• Date of declaration
• The day the board announces the dividend
• Once declared, the dividend becomes a legal
  liability of the company
• Date of payment
• The company mails dividend checks
• Date of record
• Establishes who will receive dividend checks
• Shareholders of record are listed on the company
  records as being owners of the company on the
  date of record

11

• Ex-dividend date
• Two business days prior to the date of record
• If you buy the stock before the ex-dividend date,
  you will get the next dividend
• If you buy the stock on the ex-dividend date, you
  will not get the next dividend
• Eliminates any ambiguity about who is entitled to
  the dividend

12
Why Dividends Do Not Matter?

• Payment of dividends reduces the balance in the
  firms cash account
• The firm should not be worth as much after paying
  a dividend
• The ex-dividend date determines whether or not
  you get the dividend
• On the ex-dividend date, the price of a share of
  stock tends to fall by about the amount of the
  dividend to be paid

13
Why dividend policy matters?

• Most firms increase their dividend annually, and
  the market expects this
• If management does not increase the dividend as
  expected, the market views it as bad news
• Reducing or omitting a dividend is a very bad
  signal
• An increase in dividends above what the market
  expects is a good signal

14
Stock Splits

• A stock split occurs when a firm changes the
  number of shares of its capital stock without
  changing the aggregate value of these shares
• A stock split is generally a neutral occurrence
• The primary motivation is to reduce the price of
  shares to bring it into an optimal trading range

15
Why Firms Split Their Stock

• Some literature supports the existence of an
  optimal trading range
• A principal reason for splitting shares is to
  broaden the ownership base
• Reverse splits are sometimes used to reduce the
  number of shareholders
• E.g., a 1-for-200 splits eliminates all
  shareholders holding fewer than 200 shares

16
Value investing

• Value investors look for undervalued stock
• Value investors look for low price/ earnings and
  price/book ratios

17
Growth Investing

• Growth investors look for price momentum
• Look for stocks that are in favor and have been
  advancing
• Look for stocks that are likely to be propelled
  even higher
• Normally, they invest in stocks with high P/E and
  P/B ratios
• The market moves in cycles
• Many investors own both growth and value stocks

18
Capitalization

• Capitalization refers to the aggregate value of a
  companys common stock
• Typical divisions are
• Large cap (10 billion or more)
• Mid-cap (between 500 million and 10 billion)
• Small cap (less than 500 million)
• Many money managers distribute their assets
  across size and style spectrums

19
Categories of Stock

• Blue chip stock
• Income stocks
• Cyclical stocks
• Defensive stocks
• Growth stocks
• Speculative stocks
• Penny stocks

20
Blue Chip Stock

• Blue chip has become a colloquial term meaning
  high quality
• Some define blue chips as firms with a long,
  uninterrupted history of dividend payments
• The term blue chip lacks precise meaning, but
  some examples are
• Coca-Cola
• Union Pacific
• General Mills

21
Income Stocks

• Income stocks are those that historically have
  paid a larger-than-average percentage of their
  net income as dividends
• The proportion of net income paid out as
  dividends is the payout ratio
• The proportion of net income retained is the
  retention ratio

22
Cyclical Stocks

• Cyclical stocks are stocks whose fortunes are
  directly tied to the state of the overall
  national economy
• Examples include steel companies, industrial
  chemical firms, and automobile producers

23
Defensive Stocks

• Defensive stocks are the opposite of cyclical
  stocks
• They are largely immune to changes in the
  macroeconomy and have low betas
• Examples include retail food chains, tobacco and
  alcohol firms, and utilities

24
Speculative Stocks

• Speculative stocks are those that have the
  potential to make their owners rich quickly
• Speculative stocks carry an above-average level
  of risk
• Most speculative stocks are relatively new
  companies with representation in the technology,
  bioresearch, and pharmaceutical industries

25
Penny Stocks

• Penny stocks are inexpensive shares
• Penny stocks sell for 1 per share or less

26

• Learning outcomes
• Know what are the fundamental and technical
  analyses
• Know about cash and stock dividends spin-offs
  and rights
• Comment on the following statement Dividends do
  matter it is dividend policy that does not
  matter.
• Discuss the four dates in the life of a dividend
  payment
• Know about stock splits
• Explain the differences between value and growth
  investing.
• Discuss the categories of stock mentioned in
  this slides.