12-12-11

McGraw-Hill/IrwinFocus on Personal Finance, 2e

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

12-2

Investing in Stocks

12-12-33 Investing in Stocks

1. Identify the most important features of common and preferred stock

2. Explain how you can evaluate stock investments

3. Analyze the numerical measures that cause a stock to increase or decrease in value

4. Describe how stocks are bought and sold.

5. Explain the trading techniques used by long-term investors and short-term speculators.

Chapter Objectives

12-12-44Objective 1: identify the most important features of common and preferred stocks

Common and Preferred Stocks Two concerns for basic investors.

– Investors do not know where to get the information

– Investors do not knowwhat the information means

12-12-55

Common Stocks: The most basic form of ownership of a corporation

Reasons why corporations issue Stock– Form of Equity

• To raise money to start or expand a business.• To help pay for ongoing business expenses.• They don’t have to repay the money a

stockholder pays for stock. – Dividends not mandatory

• Dividends may be paid to stockholders out of profits, but are not mandatory. Most corporations distribute 30-70% of their earnings to stockholders.

Why Corporations Issue Common Stock

12-12-66 Why Corporations Issue Common Stock Reasons why corporations issue Stock

– Voting rights and control of the company

• In return for investing in the company, stockholders have voting rights.

• A proxy is a legal form that lists the issues to be decided at the stockholder meeting.

12-12-77 Why Investors Purchase Common Stock?

Investors can make money in three ways.– Income from dividends– Dollar appreciation

of stock value.– Possible increased value from

stock splits.

12-12-88 Preferred Stock

Preferred Stock: Stock ownership that gives the owner dividends before the common stockholder

Investors in preferred stock 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.

12-12-99 Features of Preferred Stock

Cumulative preferred stock.– Unpaid cash dividends accumulate and must be

paid before any cash dividends are paid to the common stock holders.

Convertible preferred stock.– Can be traded for shares of common stock.– Provides investor with added safety of preferred

stock and greater speculative gain through conversion to common stock.

12-12-1010 Objective 2: Explain how you can evaluate stock investments

Evaluating a Stock Issue Investors need to evaluate the company and

the industry in which the stock is issued Logical place to start is with the classification

of the stock Investors can use different sources to

evaluate stocks

12-12-1111 Evaluating a Stock Issue

INTERNET Corporation’s home page has more up-to-date

information than their printed materials. http://finance.yahoo.com allows you to conduct

research on a company, and provides a stock screener to help you choose investments.

Also the following professional advisory services can be used to evaluate stocks

www2.standardpoors.com www.fisonline.com www.valueline.com

12-12-1212 Evaluating a Stock Issue

Stock Advisory Services Prepare research materials that are a good

supplement to other sources of information. Charge a fee. Three most popular are:

– Standard and Poor’s reports.– Value Line.– Mergent’s Handbook of Common Stock.

As an investor, your job is to interpret the information provided.

12-12-1313 How to Read the Newspaper Financial Section

Most metropolitan newspapers provide basic information on stocks

Stocks are listed alphabetically Stock information is listed across the table

Corporate News A prospectus lists all the necessary information as dictated

by the Federal government. All publicly traded corporations send their stockholders an

annual report. Investors can also access the Securities and Exchange

Commission website (www.sec.gov) A number of periodicals are also good sources for financial

information

12-12-1414 Objective 3: Analyze the numerical measures that cause a stock to increase or decrease in value

Numeric Measures That Influence Investment Corporate earnings play a large part in the increase

or decrease in value of a stock. Earnings per share are the corporation’s after-tax

income divided by the number of outstanding shares of common stock. An increase in earnings is generally a healthy sign.

Price-earnings (PE) ratio.– Price of one share of stock divided by the earnings

per share of stock.– A low price-earnings ratio indicates a stock may

be a good investment, but study it over time.

12-12-1515 Numeric Measures That Influence Investment

Other factors– The dividend yield helps you monitor the value of your

investments. It is the yearly dollar amount of dividends generated by an investment divided by the investment’s current market value. An increase in current yield is considered a healthy sign.

– The total return for an investment is equal to dividends plus capital gains.

– The book value of a stock is calculated by deducting all liabilities from the corporation assets and dividing the remainder by the number of outstanding shares of common stock

(continued)

12-12-1616 Objective 4: Describe how stocks are bought and sold

Buying and Selling Stocks Primary market.

– 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.

Secondary market.– A market for existing financial securities that are currently

traded among investors via brokers.

12-12-1717 Secondary Markets for Stocks

Securities Exchanges 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.The Over-the-Counter (OTC) market. Network of dealers who buy and sell the stocks of

companies not listed on a securities exchange. Most OTC securities are traded over the NASDAQ

which is an electronic marketplace for 3,200 different companies.

12-12-1818 Brokerage Firms and Account Executives

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.

– How much advice do you want?– Nearest office and toll-free phone number?– Online and phone trading services and costs?– Fees, charges and commissions?

12-12-1919 Computerized transactions

Growing number of investors are using the computer to complete security transactions

Reasons that justify using the computer are1. Size of investment portfolio2. Ability to manage investments closely3. Capability of the computer and the software package

12-12-2020 A Sample Stock Transaction

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.

A stop order is a request to sell a stock at the next available opportunity after its market price reaches a specified amount.

12-12-2121 A Sample Stock Transaction

Commission Charges

Brokerage firms have minimum commissions for buying and selling stock ranging from $7 to $55, depending on the number of shares sold and the value of the stock.

Full service and discount brokers charge more than online brokers, but you have to make your own decisions if you use an online brokerage firm.

(continued)

12-12-2222 Objective 5: Explain the trading techniques used by long-term investors and short-term speculators

Long-Term and Short-Term Investment Strategies Long-term techniques.

– Buy and hold.– Dollar cost averaging.– Direct investment and dividend

reinvestment plans. Short-term techniques.

– Buying stock on margin (borrowing money).– Selling short (borrowing stock).– Trading in options (predetermined price).