Investing in Stocks

Chapter 12

Lesson 12.1 Evaluating Stocks

I. Characteristics of Stock A. Nearly 50 million people in the U.S.

own stocks1. There are more than 34,000

public corporations from which to choose

2. Public corporation—a company whose stock is traded openly

on stock markets3. Stockholders—owners of a

corporation

Characteristics of Stock

4. Dividends—the part of a corporation’s profits paid to stockholders

5. Capital Gain—increase in the value of the stock above the price initially paid for it

6. A capital gain becomes profit only when you sell the stock.

7. Stockholders can lose all they invest should the company fail

8. Stocks are traded in round lots or odd lotsa. Round lot—multiples of 100 sharesb. Odd lot—fewer than 100 shares

(usually higher per-share fees)

B. Common Stock

1. Common Stock—type of stock that pays a variable dividend and gives the holder voting rights.

2. Board of directors—elected by stockholders to guide the corporation, decides the amount of dividend

3. Common stockholders may vote on major policy decisions. One vote per share owned

4. May vote in person or by proxy—a stockholder’s written authorization to transfer his/her voting rights to someone else (usually company mgr)

C. Preferred Stock

1. Preferred Stock—type of stock that pays a fixed dividend and carries no voting rights

2. Always earn stated dividend, paid ahead of common stockholder

3. Less risk, usually less return

II. Classifying Stock Investments—Income, Growth, Blue Chip, Defensive, Cyclical

A. Income vs. Growth Stocks1. Stocks that have a consistent history of paying high dividends are known as income stocks.2. Investors choose income stocks in

order to receive current income in the form of dividends3. Preferred stocks usually the choice of retired people and others who want income from dividends.

Income vs. Growth Stocks

4. Growth stocks—stocks in corporations that reinvest their profits into the business so it can grow, usually pay little or no dividends

5. Investors buy growth stocks for future capital gains, growth stocks are long-term investments

B. Less Established vs. Blue Chip Stocks

1. Stocks in young, small corporations have higher overall risk than stocks of companies that have been successful for many years

2. Blue Chip Stocks—stocks of large, well-established corporations with a solid record of profitability (IBM, Coca-Cola)

3. Blue chip stocks are a conservative investment with relatively safe, stable, but moderate returns.

C. Defensive vs. Cyclical Stocks

1. Defensive stocks—one that remains stable and pays dividends during an economic decline, usually have a history of stable earnings. (Utilities, drugs, food, health care)

2. Cyclical stocks—do well when the economy is stable or growing, but do poorly during recessions—when the economy slows down. (Airlines, resorts, manufacturing companies, agriculture)

III. Determining a Stock’s Worth

A. Stock Value1. Stock certificate states the number of shares you own, the name of the

company, the type of stock (common or preferred) and the par value—an assigned (and often arbitrary) dollar

value2. Par value has nothing to do with a

stock’s market value—the price a stock is bought and sold in the

marketplace

Determining a Stock’s Worth

3. Undervalued stocks are worth more than the price for which they are selling, make good bargains for investors, but can be dangerous for business. Corporation can be vulnerable to a takeover.

4. Overvalued stocks are selling at a price that is not justified by their earnings potential. Risky for the investor, price likely to drop.

B. Stock Price—several factors affect the price you will pay for a share of stock

1. The Company—price will continue to rise if the company is in a good financial position.

2. Interest Rates—when interest rates fall below the current rate of inflation, people buy more stock and stock prices rise

Stock Price

3. The Market—if a company is in a popular industry and its products or services are selling well, its stock price will rise. If the demand for its products or service declines, the price of the stock will decrease.

4. Earnings per Share—a corporation’s after tax earnings divided by the number of common stock shares outstanding. Stockholders use earnings per share as a measure of profitability.

C. Return on Investment

1. ROI—the profit you earned on the stock as a percentage of the total cost of buying the stock

2. Must take into consideration dividends, capital gain, commission

3. Divide profit by cost.

Lesson 12.2 Buying and Selling Stock

I. The Securities Market consists of the channels through which you buy and sell securities (stocks and bonds). Need a trading agent.

A.Securities Exchanges—a marketplace where brokers who are representing investors meet to buy and sell securities

1. NYSE—New York Stock Exchange; AMEX—American Stock Exchange, both in New York City. To be listed, company must meet a minimum

Securities Exchanges

2. Floor brokers buy and sell stocks on the trading floor of the exchange

3. All buying and selling is done around trading posts, 90 different stocks assigned to each post, display units which list info about stocks sold.

Securities Exchanges

4. Orders received at a brokerage firm are phoned or sent by computer to that firm’s booth at the exchange, message given to floor broker to carry out, transaction concluded.

5. Exchange is a form of auction market where buyers and sellers are brought together to trade securities. Stock is sold to the highest bidder and bought from the lowest seller. Securities listed with NYSE are traded only during official trading hours—9:30 am to 4 pm, New York time, M—F

B. Over-the-Counter Market

1. OTC—when securities are bought and sold through brokers but not through a stock exchange

2. The over-the-counter market is a network of brokers who buy and sell the securities of corporations that are not listed on a securities exchange.

Over-the-Counter Market

3. Do not deal fact-to-face, trades are completed by telephone, and a computerized system displays current price quotations on a terminal in a broker’s office.

4. Brokers use an electronic quotation system called the NASDAQ.

5. To be listed, companies must have issued at least 100,000 shares of stock worth $1 million.

C. Bull and Bear Markets—Cycles of the stock market

1. Bull market—is a prolonged period of rising stock prices and a general feeling of investor optimism

2. Bear market—a prolonged period of falling stock prices and a general feeling of investor pessimism. Develops when investors become negative and the overall economy and start to sell stocks. Bear markets are usually short and savage.

Bull and Bear Markets

3. Bull market often lasts three to four times as long as a bear market

4. To make a profit, buy when the price is low and sell when the price is higher. Research individual stocks to judge which are likely to earn a profit.

II. Investing Strategies (Speculator or day-trader—short term; Investor—long term)

A. Short-Term Techniques

1. Playing the stock market—when you buy and sell

stocks for quick profit

2. Buy on Margina. You can borrow money from your broker to buy stock if you open a margin account and sign a contract called a margin agreement.b. Leverage—the use of borrowed money to buy securitiesc. You are betting that the stock will increase in valued. If the value of the stock does not increase, you will have to make up the differencee. Margin call—the investor must pledge additional cash or securities to serve as collateral for the loan or it is sold to pay off the loan

3. Sell Shorta. Short selling is selling stock borrowed from a broker that must be replaced at a later time. You borrow a certain number of shares from the broker, you then sell back the borrowed stock, knowing that you must buy it back later and return it to the broker. You are betting that the price will drop so you can buy it back at a lower price than you sold it for.b. If stock price increase you will lose money because you must replace the borrowed stock with stock purchased at a higher price.

B. Long-Term Techniques 1. Investing in the stock market for short-term gains can be extremely risky, most financial consultants advise you to invest for the long term2. Buy and Hold—if you buy and hold stocks for many years, you can ride out the down times. A profit or loss only occurs when you sell the stock.3. Stock split—an increase in the number of outstanding shares of a company’s stock.4. A stock split lowers the selling price of the stock, making the shares more affordable and encouraging investors to buy more.

Long-Term Techniques

5, Dollar-Cost Averaging technique involves the systematic purchase of an equal dollar amount of the same stock at regular intervals. The investor makes a profit when the selling price per share is higher than the average cost per share.

6. Direct Investment—buying stock directly from a corporation, avoid brokerage and other purchasing fees.

7. Reinvesting Dividends—using dividends previously earned on the stock to buy more shares. Avoids broker fees and other costs of receiving cash dividends.

III. Reading the Stock Listings—p. 294

1. Columns 1 and 2 show the highest and lowest price this stock sold for during the year.

2. Column 3—Lists stocks alphabetically by name (stock’s ticker symbol)

3. Column 4—shows the cash dividend per share for the year in dollars and cents.

III. Reading the Stock Listings—p. 294

4. Column 5—Yld % stands for percent yield, or the percentage of the current price the dividends represent.

5. Column 6—P/E ratio (price/earnings ratio) is the price of a share of stock divided by the corporation’s earnings per share over the last 12 months. A key factor that serious investors use to evaluate stock investments. Low P/E indicates solid investment, high P/E indicates higher risk.

6. Column 7—shows sales in hundreds of shares from the previous day—how many round lots of stock were bought and sold. Multiply by 100 to get number of shares.

III. Reading the Stock Listings—p. 294

7. Columns 8, 9, 10—show the highest, lowest, and closing price for this stock on the previous day. The closing price is the final price at the end of trading for the day.

8. Column 11—net change—compares the closing price today with the closing price of the day before. Minus means price had gone down, plus means price has gone up. Boldface means price change > 5%.

9. Check the closing prices periodically to keep track of your stock portfolio

IV. Stock Indexes

A. Stock Index—a benchmark that investors use to judge the performance of their investments e.g. Dow Jones Industrial Average—average of the price movements of 30 major stocks listed on the NYSE

B. Provides a general overview of what stock prices are doing in the stock market as a whole.

C. Standard & Poor’s 500, NASDAQ Composite Index