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Chapter 14 Stocks Corporation 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 corporations stock. 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 another company. Essentially, issuing stock is a way for corporations to raise money. 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 selling stock. 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 company. -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) Annual Report A description of a company’s business and financial well being. Its purpose is to report on the operations and financial condition of the company. Will discuss the future products and direction of a company. Stock Split 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 worth $60.) 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 a dividend. 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 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. Preferred Stock 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 usually $25. 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 Stock Preferred Stock 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. Convertible Stock 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, drugs, food) means the demands for these products is consistent regardless of economic conditions. 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 one share. 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 capitalization. -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 companies profitability. -Is generally considered the most important variable when determining share price. 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 time. 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 QuickTime™ and a decompressor are neede d to see this picture. 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. QuickTime™ and a decompressor are neede d to see this picture. 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. Stock Exchanges 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. NYSE CLIPS http://www.youtube.com/watch?v=a55G2kt93IU&feature=autoplay&list=P L598CED6B12BD94D1&index=29&playnext=2 http://www.youtube.com/watch?v=VeNDB3OlhUE&feature=autoplay&list =PL598CED6B12BD94D1&index=30&playnext=3 http://www.youtube.com/watch?v=TPUDPhpCecA& feature=related Closing Bell: http://www.youtube.com/watch?v=ZGKQSNmlI_Y&feature=autoplay&lis t=PL598CED6B12BD94D1&index=31&playnext=4 Opening Bell http://www.youtube.com/watch?v=W22VPMEWjrY Stock Exchanges 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 currency options. 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. Stock Exchanges National Association of Securities Dealers Automated Quotation (NASDAQ) 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) network. 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 securities exchange. 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. Ticker Tape Invented in 1867. Constantly keeps up to date prices of securities. Use to be on paper, now on screens. Called a stock ticker. Order Types… 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. Index 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 Commission (SEC) Government agency established by Congress in 1934 for two reasons 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) Insider Trading 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 depository institutions 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. Important Terms Gross National Product (GNP) Total value of the goods/services produced by a nation during a specific period of time. Usually a year. Recession: Happens when there is a decline in spending(downturn in economic activity) Two consecutive quarters of decline in the GNP Causes the Federal Reserve to lower prime rate to increase spending and decrease savings. Inflation: 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. Short-Term Investment Strategies 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 the broker. 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 expiration date. • Purchaser is betting the stock will increase in value before the expiration date. • 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 expiration date. Long Term Investment Strategies 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 corporation. 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 www.freeedgar.com 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.
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