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Profit from Penny Stock Prices


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									   Chapter 12
Investing in Stocks

• List the features of common stock and
  compare it to preferred stock
• Discuss how to choose the type of stock to
  buy, what affects the value of and price of a
  stock, and how to compute a stock’s return
• Explain the process of buying and selling
  stock, including auction exchanges and over-
  the-counter markets
• Describe short- and long-term investment
  strategies when buying and selling stocks
Types of Stock

• Common Stock
  • A class of stock in which the owner of the stock
    shares directly in the success or failure of a
  • Shareholders will profit when the company profits
  • Shareholders have a say in major policy decisions
    (1 share = 1 vote)
    • If you are unable to attend the shareholders meeting
      you can give your vote to someone else by giving a
  • Shareholders elect a board to oversee day to day
    operations of the business
Types of Stock                        cont’d

• Common Stock     cont’d

 • Stockholders receive their money through
   dividends (the part of the profits of a
   corporation that each shareholder
 • Stockholders can lose their investment if
   the company fails, but maximum loss is
   initial investment (the owner of a small
   business can lose personal assets if
   his/her business fails)
Types of Stock                           cont’d

• Preferred Stock
  • A stock in which dividends are fixed
    regardless of how the company is doing
  • If a company fails, the preferred
    stockholders are paid first, which makes it
    less risky than common stock
  • Preferred stockholders can lose only their
    initial investment if the company fails
  • Preferred stockholders do not have voting
Preferred Stock Payment Methods

• Participating Preferred Stock
  • Preferred stockholders get paid required dividend
  • Stated dividend is paid to common stockholders
  • Remainder of earnings is shared equally between
    preferred and common stockholders
• Cumulative Preferred Stock
  • Unpaid dividends accumulate and must be paid
    before any dividends are paid to common
Preferred Stock Payment Methods

• Participating Preferred Stock Example
  • Augusta Educational Resources Company
    has 1,000 shares of $50/share, 5%
    preferred stock and 40,000 shares of
    common stock outstanding (announced
    dividend of $1/share)
  • Board of Directors sets aside $50,000 in
    dividend disbursement
  Preferred Stock Payment Methods

  • Participating Preferred Stock Example
          Common Stock                                   Preferred Stock

2) 40,000 shares * $1/share = $40,000       1)   1,000 shares * 5% * $50 = $2,500
8) $40,000 + $3,750 = $43,750 total         6)   $3,750 + $2,500 = $6,250 total payout
9) $43,750 (total payout)/40,000 shares =   7)   $6,250 (total payout) / 1,000 shares =

               $1.09/share                                    $6.25/share

            3) $40,000 (common) + $2,500 (preferred)= $42,500 total payout
            4) $50,000 (total announced payout) - $42,500 = $7,500 (left over)
            5) $7,500 / 2 = $3,750 (extra for each)
Preferred Stock Payment Methods

• Cumulative Preferred Stock Example
  • Augusta Educational Resources Company
    has 1,000 shares of $50/share, 5%
    preferred stock and 40,000 shares of
    common stock outstanding
  • Last year, the company paid no dividends
    due to the construction of a new
    warehouse and distribution center
  • This year the Board of Directors has set
    aside $50,000 for cash dividends to
  Preferred Stock Payment Methods

  • Cumulative Preferred Stock Example
          Common Stock                                  Preferred Stock

4) $50,000(tot div) - $5,000 (pf div) =    1)   1,000 shares * 5% * $50 = $2,500
   $45,000(left for common stockholders)   2)   $2,500 * 2 (this yr and last yr)= $5,000
5) $45,000 / 40,000 shares =               3)   $5,000(payout) / 1,000 shares =
               $1.13/share                                    $5.00/share
Classification of Stock Investments

• Investors use categories to classify
  • Income / Growth
  • Penny / Blue Chip
  • Defensive / Cyclical
• Category chosen depends on how
  much risk an investor is willing to
  assume in order to obtain a larger
Classification of Investments                  cont’d

• Income Stocks
  • Stocks that have consistent histories of paying
    high dividends
  • Chosen by investors wishing to receive current
    income in the form of dividends
  • Preferred stocks pay the most certain and
    predictable dividend income
• Growth Stocks
  • Stock in companies that reinvest their profits into
    the business so that it can grow and expand
  • Chosen by investors looking for long-term
    investment. The value of the stock will go up
    over time as the company grows
  • Pay little or no dividends
Classification of Investments                  cont’d

• Penny Stocks
  • A stock that sells for less than $5
  • Highly speculative; they have the potential to
    grow substantially or lose all value
  • Typically used as a short-term investment
• Blue Chip Stocks
  • Stocks of large, well-established, and usually
    profitable businesses
  • These companies have been around for years
    (decades) and aren’t going anywhere
  • Usually expensive, but relatively safe investment
  • Typically used as a long-term investment
Classification of Investments                 cont’d

• Defensive stocks
  • Stocks that remain stable and pay dividends
    during an economic decline
  • Companies that produce things that have demand
    regardless of economic conditions (Utilities,
    drugs, food, health care, etc.)
• Cyclical Stocks
  • Stocks that do well when the economy is stable
    or growing, but often poorly during recessions,
    when the economy slows down
  • Companies in industries that are subject to ups
    and downs of the economy (airlines,
    manufacturing, tourism and travel)
Stock Values and Return on Investment

• Par Value: assigned (arbitrary) dollar
  value that is printed on stock
• Market Value: price investors are
  willing to pay for a share of stock
• Market and Par values are usually very
Stock Values and Return on Investment

• Factors affecting the price of stocks
  • The company
     • When a company is performing well, it’s stock is
  • Interest rates
     • Low interest rates cause people to look for places other
       than savings accounts and CD’s to put their money
     • As interest rates rise, people tend to put their money
       into less risky investments (CD’s, Money Market Funds,
  • Earnings Per Share (EPS)
     • A corporation’s after-tax earnings divided by the number
       of common stock shares outstanding
     • EPS is considered a measure of the company’s
       profitability (high EPS = high profits)
Calculating a Stock’s Return

• Two ways to make money with stocks
  • Dividends
  • Price appreciation (sell for price higher
    than purchase price)
• Return = money made on investment
  • Return is the difference between what you
    paid for the stock and what you sold it for
    plus any dividends you received while
    owning it less any commissions paid
Calculating a Stocks Return                             cont’d

 Current Price + Dividends
                                - 1 * 100 = Return on Investment
Purchase Price + Commission

         Current price = $40/share
         Purchase price = $38/share
         Dividends received = $1/share
         Stockbroker’s total commission = $125
         # shares owned = 100

     (100*$40) + (100*$1)
                                 - 1 * 100 = Return on Investment
        (100*38) + $125

    4000 + 100       4100
                 =          = 1.04458 – 1 = .04458 * 100 = 4.46%
   3800 + $125       3925
The Securities Market

• A securities market is where stocks are
  bought and sold
• Bull vs Bear Markets
  • Bull Market: rising stock prices and a
    general feeling of investor optimism
  • Bear Market: investors are pessimistic
    about the overall economy and start to
    sell stocks
The Securities Market                               cont’d

• Securities Exchanges
  • Securities Exchange: a marketplace where
    brokers who are representing investors meet to
    buy and sell securities
  • New York Stock Exchange (NYSE) is the largest
    securities exchange in U.S.
    • To be listed here, company must have at least 1.1
      million shares w/market value > $9 million
  • Floorbrokers buy and sell stocks on the exchange
    floor (at trading posts)
  • The exchange is an auction market (stocks sold
    to highest bidder)
The Securities Market                              cont’d

• Over-the-Counter Market (OTC)
  • A network of brokers who buy and sell the
    securities of corporations that are not listed on a
    securities exchange
  • Trades are completed by telephone or computer
  • Computerized system displays current price
    quotations on a terminal in a broker’s office
  • NASDAQ (Nat’l Assoc. of Securities Dealers
    Automated Quotation System)
     • To be listed w/NASDAQ company must have at least
       100,000 shares w/market value > $1 million
Investing Techniques

• There are two techniques for investing:
  short-term and long-term
• According to the Wall Street Journal,
  since 1926 the odds of losing money
  on the market in a given year is 30%;
  over ten years the risk is <10%
• The risk of investing in the short-term
  is much higher than in the long-term
Short-Term Investing Techniques

• Buying on Margin
  • Borrowing money from a broker to buy
    stock when you thing the value of the
    stock is going to go up
  • Hold the stock short-term until it
  • Sell the stock and pay back the money
    you borrowed from your broker
  • Investor loses money if market value of
    stock drops
Short-Term Investing Techniques
Short-Term Investing Techniques

• Selling Short
  • Selling short is a technique that you use when
    you think the value of the stock is going to
  • You borrow stock from a broker, and immediately
    sell it; after the market value of the stock
    depreciates, you buy it back and return the
    shares that you borrowed to the broker
  • Your profit is the difference between what you
    made when you sold the borrowed stock initially
    and what it cost you to buy shares to return less
Short-Term Investing Techniques
Long-Term Investing Techniques

• Buy and Hold
  • Buy stock and hold on to it long-term
  • Earn money through dividends while
    holding on to the stock
  • Stock splits can increase the value of
    stocks over time
    • Company increases the amount of shares
      outstanding and decreases the price
    • Over time the price will work itself back up
Long-Term Investing Techniques

• Dollar-Cost Averaging
  • Systematic purchase of an equal dollar
    amount of the same stock at regular
  • This technique avoids the situation of
    buying high and selling low because as
    long as the selling price is higher than the
    average price of shares owned, the
    investor will make a profit
Long-Term Investing Techniques

• Direct Investment
  • Investors buy stock directly from a
  • Broker fee is reduced or absorbed by the
• Dividend Reinvestment
  • Instead of receiving cash from a company
    as dividends, investors receive shares of
    stock equal to the dividend amount.
  • No broker fee
Reading the stock listing

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