Chapter 14 Stocks
A legal entity separate from its shareholders.
This means that an individual shareholder in a corporation is not
directly responsible for the actions for the corporation.
In the event of bankruptcy, the financial loss to the
shareholders is limited to their investment in the
A public corporation is a company whose stock
is traded openly on stock markets.
Why Issue Stock?
Corporations issue stock to raise capital to finance
anything from new equipment purchases to taking over
Essentially, issuing stock is a way for corporations to
When a company first issues shares it is often termed
“going public” since they are making part of the
company available to the public in the form of shares.
IPO - Initial Public Offering.
Corporations can issue common and preferred stock.
Share of Stock
A unit of ownership in a corporation.
Stocks are traded in round lots or odd lots.
Round lot is 100 shares or multiples of 100 shares
Odd lot is fewer than 100 shares of a particular stock
Shareholders usually pay a commission when buying and
The commission may be a straight fee for each trade. Ex: $8 per trade.
The commission may be a percentage of the purchase or selling price.
Ex: 2% for each trade.
Role of a shareholder
When you buy stock, you are buying a piece of a
-You become part owner, along with other individuals and
institutions that hold shares.
-As a shareholder; you can never lose more than you invest.
Board of Directors
A group of people elected by the stockholders to
manage a corporation.
If the corporation makes a profit (net income) they
decide whether or not to distribute earnings back to
the stockholders in the form of a dividend.
They do not have to declare a dividend. They may keep the
earnings and reinvest into the company. (retained earnings)
A description of a company’s business and financial well being.
Its purpose is to report on the operations and financial condition of the
Will discuss the future products and direction of a company.
A stock split occurs when a company increases shares
outstanding, but lowers the selling price in direct proportion.
Will see a tiny s on listing.
Why would a company want to split their stock:
A lower share price makes the stock more affordable for investors.
2for1split (Ex: stock is trading at $80 and you have one share, after
the split you now have two shares now worth $40.)
They can also reverse split so there are not as many shares
outstanding. 1for2split (Ex: stock is trading for $30 a share and you
have two shares, after the reverse split, you now have one share
Two ways to make money
through owning stock
Dividend Income (Quarterly)
When a company does well, stockholders may receive dividends.
Dividends are the part of the profits of a corporation that are distributed
back to each shareholder.
The Board of Directors decide if a dividend will be distributed at all and if
so, how much, and when.
When a company cancels or reduces its dividend, its share price may
decline as the stock becomes less appealing to investors. If a dividend
increases, the stock becomes more attractive to investors who want to earn
Capital Gain (price appreciation)
Is made when an investor sells a stock for more than was originally paid.
A rate return is how much money you make from your investment.
-Short term: Stock owned less than a year; capital gain is taxed at ordinary
income tax rates!
-Long term gain: Held stock over a year; capital gain will be taxed at a
lower rate with the current maximum being 15%
Common Stock - the owner shares directly in the success or
failure of a business.
-You profit when company profits
-Have a say in company decisions
Should company issue additional stock
Sell the company to outside buyers
Change the board of directors
You get one vote for each share owned.
-If you cannot vote in person you vote by proxy, which is giving your voting
rights to someone else. A proxy is valid until you revoke it.
Stock Certificates usually state the number of shares owned,
the name of the company issuing the stock, the type of stock
(common/preferred) and the par value.
Dividends are fixed, regardless of how company is doing.
Less risky than common stock.
If company fails the preferred stockholder gets paid first.
Preferred stockholders do not have voting rights.
2 Types of Preferred Stock
Cumulative Preferred Stock
Convertible Preferred Stock
The par value is an assigned dollar value for preferred stock
Reason they assign a par value is to compute ratios, to determine
dividends paid and to use as a benchmark for trading. Most people
buy preferred stock because of the dividend income which is based
on percentage of par value.
Cumulative & Convertible Preferred
The required dividend is paid to preferred stockholders
A stated dividend is paid to common stockholders
The remainder of the earnings available for distribution is shared by both
preferred and common stockholders
Cumulative Preferred Stock
If a corporation’s board of directors votes not to pay dividends, they can
omit dividends paid to both common and preferred stockholders.
It is an issue whose unpaid dividends accumulate and must be paid before
any cash dividends are to be paid to the common stockholders.
So if a company does not pay a dividend in 1999, but in 2000 has 100,000
to distribute, preferred stockholders get their dividends first that include
the dividend they did not get in 1999.
Can be exchanged, at the stockholder’s option, for a specified number of
shares of common stock.
Types of Stock
Income Stocks - are stocks that have a consistent history of
paying high dividends.
Growth Stocks- stocks in companies that reinvest their profits
into the business so that they can grow and expand. They
usually pay little or no dividends. Investors buy them for their
increase in value.
Blue Chip - companies that are large, well-established and
financially solid. Maintain a fairly stable price during ups and
downs of the market. Usually pay small but regular dividends.
Penny Stock- stocks that have a traded value of under $5 per
share. (high risk)
Types of Stock Continued
Defensive stock- shares that remains stable and pay dividends
during an economic decline.
Usually has a history of stable earnings
Not subject to the ups and downs of business cycles (utilities,
means the demands for these products is consistent regardless of
Cyclical stock- shares do well when the economy is stable or
growing, but often poorly during recessions.
Airlines, travel based industries, automobile, home builders
What is Market Cap?
Market Capitalization is the total dollar market value of all of
a company's outstanding shares.
Market capitalization is calculated by multiplying a
company's shares outstanding by the current market price of
The investment community uses this figure to determining a
company's size, as opposed to sales or total asset figures.
If a company has 35 million shares outstanding, each with a
market value of $100, the company's market capitalization is
$3.5 billion (35,000,000 x $100 per share).
-Large Cap: $10 billion plus and include the companies with the largest market
-Mid Cap: $2 billion to $10 billion
-Small Cap: Less than $2 billion
Things that affect price of stock
The financial condition of the company. “Earnings”
Current interest rates.
The market for a company’s products or services.
Market value reflects the price investors are willing to pay for
a share of stock.
If people are paying more than the stock is “worth” it is considered
“overvalued” and likewise, if a stock is trading at an amount less than what
it is worth it is “undervalued”
Earnings per share- a corporations after-tax earnings divided
by the number of shares outstanding. It is a measure of the
-Is generally considered the most important variable when determining
Earnings Per Share = After Tax Income/Outstanding Shares
Things that affect price of stock
Price-Earning Ratio- a ratio of a company’s current share price
compared to it’s per-share earnings. Shows how much investors
are willing to pay per dollar of earnings
PE Ratio = Market Value Per Share/Earning Per Share
-If P/E is 20 that means investors are willing to pay $20 for $1 of current
earnings. The lower the number the more undervalued.
PEG Ratio - a ratio that shows the relationship between the
price/earnings ratio and earnings growth- tells a much more
complete story than the P/E on its own.
PEG Ratio=Price/Earnings Ratio/Earnings Per Share Ratio
-The lower the number the more undervalued
Bid, Ask, Spread…
A two-way price quotation that indicates the best price at
which a security can be sold and bought at a given point in
The bid price represents the maximum price that a buyer or
buyers are willing to pay for a security.
The ask price represents the minimum price that a seller or
sellers are willing to receive for the security.
A trade or transaction occurs when the buyer and seller agree
on a price for the security.The difference between the bid and
asked prices, or the spread, is a key indicator of the liquidity
of the asset - generally speaking, the smaller the spread, the
better the liquidity.
Also known as bid and ask, bid-ask or bid-offer.
Reading A Stock Table/Quote
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Columns 1 & 2: 52-Week High and Low - These are the highest and lowest prices at which a
stock has traded over the previous 52 weeks (one year).
Column 3: Company Name & Type of Stock - This column lists the name of the company. If
there are no special symbols or letters following the name, it is common stock. Different symbols
imply different classes of shares. For example, "pf" means the shares are preferred stock.
Column 4: Ticker Symbol - This is the unique alphabetic name which identifies the stock. If you
watch financial TV, you have seen the ticker tape move across the screen, quoting the latest
prices alongside this symbol.
Column 5: Dividend Per Share - This indicates the annual dividend payment per share. If this
space is blank, the company does not currently pay out dividends.
Reading A Stock Table/Quote
Column 6: Dividend Yield - The percentage return on the dividend. Calculated as annual dividends per share
divided by price per share.
Column 7: Price/Earnings Ratio - This is calculated by dividing the current stock price by earnings per share
from the last four quarters.
Column 8: Trading Volume - This figure shows the total number of shares traded for the day, listed in hundreds.
To get the actual number traded, add "00" to the end of the number listed.
Column 9 & 10: Day High and Low - This indicates the price range at which the stock has traded at throughout
the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.
Column 11: Close - The close is the last trading price recorded when the market closed on the day. If the closing
price is up or down more than 5% than the previous day's close, the entire listing for that stock is bold-faced. Keep
in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly
changing (even after the exchange is closed for the day). The close is merely an indicator of past performance and
except in extreme circumstances serves as a ballpark of what you should expect to pay.
Column 12: Net Change - This is the dollar value change in the stock price from the previous day's closing price.
When you hear about a stock being "up for the day," it means the net change was positive.
Reading A Stock Table/Quote
Quotes on the Internet Today, it's far more convenient for most to
get stock quotes off the Internet. This method is superior because
most sites update throughout the day and give you more
information, news, charting, research, etc.
To get quotes, simply enter the ticker symbol into the quote box of
any major financial site like Yahoo! Finance, CBS Marketwatch, or
MSN Moneycentral. The example below shows a quote for Microsoft
(MSFT) from Yahoo Finance. Interpreting the date is exactly the
same as with the newspaper.
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Calculating Rate of Return
Rate of Return tells the investor the percentage gain or loss
on an asset based upon his purchase price.
-To calculate total return, divide the selling value of the position plus any
dividends received by its total cost.
A market place that brings buyers and sellers of securities
(stocks and bonds) together.
Prices of securities are dictated by supply and demand.
Each stock has two sides, a buyer and seller. (Bid & Ask)
To be listed on a major stock exchange, a company has to meet certain
financial and legal requirements.
New York Stock Exchange (NYSE) (Big Board)
Established May 17, 1792
Largest stock exchange in U.S.
-Is now a publicly traded company (2007) NYSE Euronext
To have a stock listed on NYSE, must have 1.1million publicly traded
shares with a market value of $9million.
Bell rings at 9:30a.m. to open and at 4p.m. to close.
Also known as the "Big Board", the NYSE relied for many years on floor
trading only, using the open outcry system. Today, more than half of all
NYSE trades are conducted electronically, although floor traders are still
used to set pricing and deal in high volume institutional trading.
American Stock Exchange (AMEX)
Was known as the curb exchange until 1921is located in Manhattan, NY
Holdings of small to medium size companies 250,000 shares worth 2.5million.
Philadelphia Stock Exchange (PHLX)
The first stock exchange in North America
Is the marketplace for the trading of stocks, equity options, index options and
Chicago Board of Options (CBOE)
Revolutionized options trading by creating standardized, listed options in 1973.
-Before 1973, options were individually tailored and traded “over-the-counter” by a
few put/call dealers. Worlds largest options exchange.
National Association of Securities Dealers Automated Quotation
Owned and operated by NASD (National Association of Securities Dealers)
The worlds first electronic stock market.
Trades with other brokers are completed by telephone or computer.
To be listed with the NASDAQ, companies must have issued at least 100,000
shares of stock, worth $1 million.
Several regional locations - created in 1971
Home to many high tech stocks: Microsoft, Intel, Dell,
Usually have 4 or 5 letter ticker symbols unless previously traded on NYSE
Over the Counter Markets
When securities are bought and sold through brokers, but not
through an exchange, it is called an electronic over-the-counter
OTC stocks are bought and sold through negotiation via telephone or computer
contact between a network of brokers who buy and sell securities not listed on a
No trading floor.
In general, the reason for which a stock is traded over-the-counter is usually
because the company is small, making it unable to meet exchange listing
requirements. Also known as "unlisted stock", these securities are traded by
broker-dealers who negotiate directly with one another over computer networks
and by phone.
Although Nasdaq operates as a dealer network, Nasdaq stocks are generally not
classified as OTC because the Nasdaq is considered a stock exchange.
As such, OTC stocks are generally unlisted stocks which trade on the Over the
Counter Bulletin Board (OTCBB) or on the pink sheets. Be very wary of some
OTC stocks, however; the OTCBB stocks are either penny stocks or are offered by
companies with bad credit records.
Invented in 1867.
Constantly keeps up to date
prices of securities.
Use to be on paper, now on
Called a stock ticker.
Three types of orders used to trade stocks:
• Market Order - a request to buy or sell stock at the
current market value.
• Limit Order - a request to buy or sell a sock at a
specified price or better.
• Stop Order (Stop-Loss Order) is an order to sell a
particular stock at the next available opportunity
after its market price reaches a specified amount.
An index is an average of stocks to see how stocks are
performing overall and help investors gauge the market.
Two Popular stock indexes:
-Dow Jones Industrial Average Dow Explained
World’s oldest and best known stock index, began July 1884.
An index of 30 Large Cap. stocks representing a variety of industries
Gives people general idea of how market is doing.
-Standard & Poor’s 500
Measurement of changes in the stock market conditions based on the
average performance of 500 widely held common stocks.
Stock market professionals prefer this index because it gives a broader
picture of the general movement of stocks.
The S&P 500 is one of the most commonly used benchmarks for the overall U.S. stock
market. The Dow Jones Industrial Average (DJIA) was at one time the most renowned
index for U.S. stocks, but because the DJIA contains only 30 companies, most people
agree that the S&P 500 is a better representation of the U.S. market. In fact, many
consider it to be the definition of the market.
Securities & Exchange
Government agency established by Congress in 1934 for two
To provide full disclosure to investors (annual reports)
To prohibit fraud in connection with the sale of securities
SEC monitors illegal actions (Wall Street Police)
Manipulation of stock prices
Falsification of corporate records
Other ill-gotten gains
SEC tracks the market for unexplained price moves.
May receive Fines and or Jail time for illegal actions
Federal Reserve Bank
Government Agency that has four basic functions
Influences the supply of money and credit
Regulates & supervises financial institutions
Serves as a banker for the government
Supplies payment services to the public through
Is responsible for keeping the economy in balance by
controlling interest rates and money supply
Chairman of the Federal Reserve Bank is
Dr. Ben Bernanke.
Gross National Product (GNP)
Total value of the goods/services produced by a nation during a specific
period of time. Usually a year.
Happens when there is a decline in spending(downturn in economic
Two consecutive quarters of decline in the GNP
Causes the Federal Reserve to lower prime rate to increase spending and
Happens when there is a rise in spending.
Too much money chasing too few goods
Causes the Federal Reserve to increase prime rate rates to decrease
spending and increase savings.
Bull Market: stocks are on an upward trend.
Bear Market: stocks are on a downward trend.
When you buy and sell stocks for quick profits, you are
“playing the market” or called a “speculator”
Buying on Margin: Borrowing money from your broker to
buy stock if you open a margin account and sign a contract
called a margin agreement.
With a margin purchase, you are betting that the stock will increase
in value. When the stock does, you repay the loan, and take your
short-term profit. If is decreases, you will have to make up the
difference. When the stock gets to 1/2 of the original purchase
price, you will get a margin call from your broker.
Short-Term Strategies Cont’
Selling Short is selling stock borrowed from a broker
that must be replaced at a later time.
You borrow a stock certificate for a certain number of shares from
When you sell short, you sell the borrowed stock knowing that
you must cover your short position at a later date.
When the stock price drops, you purchase the stock at a lower
price than you sold the borrowed stock for. Then you replace the
lower priced stock with the original higher priced stock.
There is usually no broker fee when selling short, but the firm
receives a commission
Short-Term Strategies Cont’
Trading in Options an option gives you the right to buy or sell a stock at a
predetermined price during a specified period of time.
• Available for three, six, or nine-month periods
• Call Option is sold by a stockholder and gives the purchaser the right
to buy 100 shares of stock at a guaranteed price before a specified
• Purchaser is betting the stock will increase in value before the expiration
• Put Option is the right to sell 100 shares of stock at a guaranteed
price before a specified expiration date.
• The purchaser is betting that the stock will decrease in value before the
Long Term Investment
People who hold stocks for a long period of time are referred
to as “investors”
Buy and Hold: When an investor buys a stock and holds on to
it for a long period of time.
Dollar-Cost Averaging: Involves the systematic purchase of
an equal dollar amount of the same stock at regular intervals.
Direct Investment: Investors buy stock directly from a
Dividend Reinvestment Program (DRIP): When dividends
are used to purchase new shares of stock including fractional
shares, a method that avoids a broker fee.
How to Research Stocks
1. Obtain corporate financial statements filed with the Securities and
Exchange Commission. You can get such documents without charge via
2. Analyze quarterly statements covering two or three years, noting trends
in earnings per share and revenue.
3. Look for a trend of consistent growth in earnings per share
4.Calculate the company's price-earnings (PE) ratio, a measure of a stock's
value (Divide the stock price by annual earnings per share.)
5. Compare the PE ratio with industry norms and with the S&P 500's ratio.
The lower the ratio, the less expensive the stock is relative to earnings.
6. Beware of debt. Check out the company's balance sheet, looking for the
extent of its long-term debt.
7. Check cash flow - the movement of cash through the company. You'll
want the company to have positive cash flow.