Common Stock Investments

Dhanashri Academy

Key Topics

Key topics include:long-term perspective;advantages and disadvantages;characteristics, new issues, stock quotations

and transaction costs; measures of common stock value;dividends;different kinds of common stock; anduses and strategies of common stock

investing.

Common StockRepresents ownership in a corporation and

allows investors to participate in the profitsStocks offer investors the opportunity to

shape an investment program to their individual needs

Stock ReturnsStock returns come mainly from capital

appreciationStock market returns have averaged about

12% per year over the past 50 years, but over 18% during the past decade

Advantages: Common StockPotential for high returns; no upper

limits. May provide current income return from

dividends.Shares are highly liquid and easily

transferred. Transaction costs are relatively low; on-

line trades can be very cheap. Low unit prices relative to other

securities.

Disadvantages: Common StockEarnings and performance are subject to

wide swings.

Selection of common stocks is complex. Current income is relatively low, compared

to bonds.

Publicly Traded StocksPublic offering

an offering to sell to the investing public a set number of shares of a firm's stock at a specified price

Rights offering an offering of a new issue of stock to existing

shareholders, who may purchase new shares in proportion to their current ownership position

Publicly Traded StocksStock spin-off

a conversion of one of a firm's subsidiaries to a stand-alone company by distribution of stock in that new company to existing shareholders

Stock splitsa maneuver in which a company increases

the number of shares outstanding by exchanging a specified number of new shares of stock for each outstanding share

Publicly Traded StocksTreasury stock

stock that has been sold and subsequently repurchased by the issuing firm

Classified common stockStock issued by a company in different

classes, each of which offers different privileges and benefits to its holders

Buying and Selling Stocks

The investor must be familiar with stock quotes

The investor must also consider transaction costs

Stock QuotesNYSE – New York Stock ExchangeAMEX – American Stock ExchangeNASDAQ

Published in a twelve-column format

Column Titles52 weeks Hi

highest price within past year, adjusted for stock splits if any

52 weeks Lo lowest price w/n past year

Stock name of company

Column Titles (2 of 5)Sym

ticker symbol; 1-3 characters on NYSE and AMEX; 4-5 on NASDAQ.

Div annual dividend

Column TitlesYld %

dividend yield based on current annual dividend divided by market price PE - price-earnings ratio based on most recent four quarters of earnings

Vol 100s number of shares traded yesterday (in 100s)

Column TitlesHi

highest price at which stock traded yesterdayLo

lowest price yesterday Close - closing price yesterday

Column TitlesClose

closing price yesterday Net Chg

change in price from close of previous day

Transaction Costsaverage 1-5% of value of transaction when

using a full-service broker

Odd-lot trades (less than 100 shares) carry an added cost called odd-lot differential

Transaction Costs (continued)Discount brokers can save an investor up

to 70% on commission

On-line trades can now cost less than $ 10 per trade

Measures of ValuePar value

the stated or face value (meaningless for investment purposes)

Book value the amount of shareholder equity in a

company; equals the amount of the firm's assets minus liabilities and preferred stock

Measures of Value (continued)Market value

the prevailing price of a security.Investment value

the amount that investors believe a security should be trading for, or what they think it's worth.

Dividends and Earnings per Share (EPS)The directors make the dividend decisions

based on several factors.Earnings per share (EPS) represents the

amount that is earned per shareEPS = (net profit after taxes - pfd

dividends)# shares outstanding

Dividends and Earnings per Share (EPS)Dividends are paid out of earnings, but do

not have to be paid even when the firm is profitable

Generally, however, higher EPS lead to higher dividends

Dividends (Important dates)Record date

date on which an investor must be a registered shareholder to be entitled to receive a dividend

Ex-dividend date 3 business days prior to the date of record;

determines if one is an official shareholder and thus eligible to receive a declared dividend

Payment date the actual date on which the company pays

the dividend

Cash Dividends and the Dividend YieldDividends are normally paid in cash,

although stock dividends are also common.

Cash dividends are current income, which can be expressed as the dividend yield.

Dividend yield = annual dividend per share market price per share

Dividend Payout Ratio (DPR)One measure of stability of the cash

dividend is the dividend payout ratio (DPR). DPR = dividend per share / current market

price per share.A high DPR could suggest difficulty in

paying future dividends.

Dividend Reinvestment Plans and Stock DividendsDividend reinvestment plans (DRIPs)

plans in which shareholders have cash dividends automatically reinvested into additional shares.

Stock dividend A dividend payment in the form of additional

shares of stock.

Market Classifications of Common StockBlue chip stocks

financially strong, high quality stocks with long and stable records of earnings and dividends.

Income stocks Have long and sustained records of paying

higher-than-average dividends. Growth stocks

experience high rates of growth in operations and earnings.

Market Classifications of Common StockSpeculative stocks

offer the potential for substantial price appreciation, usually because of some special situation, such as new management or the introduction of a promising new product.

Cyclical stocks Stocks whose earnings and overall market

performance are closely linked to the general state of the economy.

Market Classifications of Common StockDefensive stocks

tend to hold their own, and even do well, when the economy starts to falter.

Mid-cap stocks medium-sized stocks, generally with market

value of less than $3-4 billion, but more than $750 million.

Small-cap stocks have market value of less than $750 million,

and may offer above-average returns.

Foreign StocksForeign equity markets

outperform US markets in most years Investors can buy foreign stocks directly

Has many logistical problems American Depository Receipts (ADRs)

Backed by foreign securities held by US banks

Foreign StocksBoth direct purchase and ADRs

have usual risks associated with common stocks, plus the currency exchange rate risk that drastically can affect total return.

Total return in US$ = dividends + cap gains (losses) + (or) - changes in FOREX rates.

Investment StrategiesInvestment strategies can be employed to

satisfy one of three basic investment needs:

warehouse of value accumulation of capital and/or as a source of income

Buy-and-Hold Strategy and The High-Income ApproachThe most basic strategy is the buy-and-

hold. High-quality stocks are selected and held for

extended periods; a strategy popular with value-oriented investors.

The high-income approach uses common stocks for current income.

Since dividends mostly increase through time, the level of current income increases as well.

Quality Long-Term Growth and Aggressive Stock Management

Quality long-term growth a less conservative strategy. This strategy

relies on capital gains as the primary source of return.

Aggressive stock management uses quality issues to seek attractive rates of

return in a fully managed portfolio. has substantial risk and requires a

substantial amount of investor time.

Speculation and Short-Term TradingSpeculation and short-term trading

the highest risk strategy.investor seeks returns from capital gains

while holding the stock only a short period of time.

Using Investment StrategiesThe first three strategies go well with the

objective to use stocks as a warehouse of value

All five could be used to accumulate capitalThe high-income strategy fits best with the

objective of using stocks as a source of income

Popular Investment Strategies Some Popular Investment Strategies Include:

Growth Investing, which is investing in stocks with above average forecasts of earnings growth and high price/earnings ratios in expectation of higher returns.

Value Investing, which is investing in stock of companies that are out of favor with the market for some reason, as reflected by low price/earnings ratios and low prices compared to their fundamentals.

Sector Investing, which is an investing style based on the premise that certain industry sectors perform better during specific stages of the economic cycle.

Momentum Investing, which is an investing style that focuses on using relative stock price movement to determine when to buy and sell.