Investment in Equity

Learning GoalsWhat is equity marketWhat is common stock. and what is Preferred

stockType of common stock and Preferred stockStrategy and style in investing in common

stock

Equity InvestmentCommon Stock and Preferred Stock2 types of rights

Voting Right Right to vote Elect management of corporation

Preemptive Right Right to keep proportionate ownership of the

company Let common shareholders buy new shares of stock

before non-stockholders

Other Rights of Common StockholdersRight to inspect the books and records of the

companyPrivilege of receiving dividends as cash, stock

or propertyRight to receive distributions of any remaining

assets should the company go out of business

An Overview of Common Stock Represents ownership in a corporationKnown as equity securities or equities

representing ownership shares in a corporationVoting rightNo maturity dateCharacteristics of common stock

Residual claim - claim on the assets of a firm that goes bankrupt. Receive the assets after all other creditors, bondholders and preferred shareholders

Limited Liability – shareholders only lose their amount of investment and not their personal belongings

Common Stock DividendMay be paid in cash, stock or propertyDetermines by Board of DirectorsIncreases or reductions are depend on how

well the company is performingCorporate or Market Factors is one of the

factors in making a decision to pay out dividends

Types of Common Stock DividendCash Dividends are those that are paid out in

cash form

Stock Dividends are dividends paid out in the form of additional stock shares in the corporation, or shares of a subsidiary corporation

Property Dividends are paid with assets owned by the issuing company

Types of Common StocksBlue Chip Stocks: financially strong,

high-quality stocks with long and stable records of earnings and dividendsCompanies are leaders in their industriesRelatively lower risk due to financial stability

of companyPopular with investing public looking for

steady growth potential, perhaps dividend income

Provide shelter during unsettled marketsExamples:

Income Stocks: stocks with long and sustained records of paying higher-than average dividendsGood for investors looking for relatively safe

and high level of current incomeDividends tend to increase over time (unlike

interest payments on bonds)Some companies pay high dividends because

they offer limited growth potentialMore subject to interest rate riskExamples:

Growth Stocks: stocks that experience high rates of growth in operations and earningsHave sustained rate of growth in earnings above

general marketInvestors expect higher price appreciation due to

increasing earningsRiskier investment because price may fall if

earnings growth cannot be maintainedMay include blue chip stocks as well as

speculative stocksTypically pay little or no dividendsExamples:

Tech Stocks: stocks representing the technology sector of the marketRange from speculative stocks of small

companies that have never shown a profit to blue chip stocks of large companies that are growth-oriented

Potential for attractive returnsConsiderable risk and volatilityDifficult to put value on due to erratic or no

earningsExamples:

Speculative Stocks: stocks that offer potential for substantial price appreciation, usually due to some special situation such as a new productCompanies lack sustained track record of

business and financial successEarnings may be uncertain or highly unstablePotential for substantial price appreciationStock price subject to wide swings up and

down in value

Examples:

Cyclical Stocks: stocks whose earnings and overall market performance are closely linked to the general state of the economyStock price tends to move up and down with the

business cycleTend to do well when economy is growing,

especially in early stages of economic recoveryTend to do poorly in slowing economyBest for investors willing to move in and out of

market as economy changesExamples:

Defensive Stocks: stocks that tend to hold their value, and even do well, when the economy starts to falterStock price remains stable or increases when

general economy is slowingProducts are staples that people use in good

times and bad times, such as electricity, beverages, foods and drugs

Gold stocks are a form of defensive stockBest for aggressive investors looking for

“parking place” during slow economyExamples:

Mid-Cap Stocks: medium-sized companies with market capitalizations between $1 billion and $4 or $5 billionProvide opportunity for greater capital

appreciation than Large-Cap stocks, but less price volatility than Small-Cap stocks

Usually have long-term track records for profits and stock valuation

“Baby Blues” offer same characteristics of Blue Chip stocks except size

Examples:

Small-Cap Stocks: small companies with market capitalizations less than $1 billionProvide opportunity for above-average returns

(or losses)Usually do not have a financial track recordEarnings tend to grow in spurts and can have

dramatic impact on stock priceUsually not widely-traded; liquidity is an issue“Initial Public Offerings (IPOs)Examples:

Alternative Investment StrategiesBuy-and-Hold

Investors buy high-quality stocks and hold them for extended time periods

Goal may be current income and/or capital gains

Investors often add to existing stocks over timeVery conservative approach; value-oriented

High IncomeInvestors buy stocks that have high dividend

yields

Safety of principal and stability of income are primary goals

May be preferable to bonds because dividends levels tend to increase over time

Often used to provide to supplement other income, such as in retirement

Quality Long-Term GrowthInvestors buy high-quality growth stocks, mid-

cap stocks and tech stocksCapital gains are primary goalHigher level of risk due to emphasis on capital

gainsSignificant trading of stocks may occur over timeDiversification is used to spread risk“Total Return Approach” is version that

emphasizes both capital gains and high income

Aggressive Stock ManagementInvestors buy high-quality growth stocks, blue

chip stocks, mid-cap stocks, tech stocks and cyclical stocks

Capital gains are primary goal

High level of risk due to emphasis on capital gains

Investors aggressively trade in and out of stocks, often holding for short periods

Timing the market is key element

Time consuming to manage

Speculation and Short-Term TradingAlso called “day trading” Investors buy speculative stocks, small-cap

stocks and tech stocksCapital gains are primary goalHighest level of risk due to emphasis on capital

gains in short time periodInvestors aggressively trade in and out of stocks,

often holding for extremely short periodsLooking for “big score” on unknown stockTime consuming & high trading costs

Investment StylesGrowth Investing

is investing in stocks with above average forecasts of earnings growth and high price/earning ratios in expectation of higher return.

Investors need to monitor both company’s performance and industry trend closely, because these stocks are sensitive to change.

Riskier than other styles as they rise faster and fall faster.

Strategies - focus on capital appreciation; quality long-term growth, aggressive stock management, and even speculation.

Value Investing focuses on companies that are out of favor with

the market. Value investors buy stocks whose prices are low

compared to their fundamentalsLow price/earnings ratios, low price-to-book

value ratios and high dividend yields Investors expect some particular action – new

management, corporate take over, regulatory change, etc – to drive up the price.

cyclical industries such as automobiles, chemicals, steel, financial services or real estate companies

Use buy-hold strategy.

Sector Rotation StyleInvestors choose stocks in specific industry sectors

that will do best depending on the current and projected stages of the business/economic cycle.

Do not look at the fundamentals of individual companies but look at the economy as a whole and forecast for the future.

Divide stocks into four broad sectors interest sensitive stocks, consumer durables, capital good manufacturers, defensive stocks

Investors rotate from one type of stock to the next as the economy moves from one stage of the business cycle to the next.

Strategies - aggressive stock management and even a bit of short-term trading.

Momentum Investing Rely heavily on technical analysis – focuses on

using relative stock price movement to determine when to buy and sell rather than fundamental of underlying companies.

aggressive stock management or speculation and short-term trading strategies.

Preferred StockRepresents ownership in a corporationFixed dividends and a claim on a company's

assets that is above that of common shareholders

Issued with a RM100 par (face) value

Types of Preferred StockCumulative preferred stock - continuous claim

to dividends. Any unpaid dividends accumulate until the corporation resumes paying them.

Non-cumulative (straight) preferred - opposite of cumulative preferred: it doesn't confer a steady claim on dividends in the event of a dividend suspension

Participating preferred - shareholders receive extra dividends over their nominal

Convertible preferred - converted to a certain number of shares of common stock

Features of Preferred StockLimited voting right

When the company wants to merge with another When the company wants to liquidate a large portion

of its assets When the company wants to issue new bonds or

preferred stock Call provision

the issuing company can repurchase the stock from the shareholders.

As a way to eliminate dividends, thus increasing earnings for common shareholders.

ConversionTo convert to a specified number of shares of

the issuing company’s common stock. Adjustable-rate (floating-rate) preferred Preference (prior preferred) stock A cumulative provision

Advantages Investing in Preferred Stocks

Preferred stocks offer high current income.Preferred stockholders generally receive

higher rate of return than bondholdersSmall investors are encouraged by the low

unit cost of preferred stocks.Preferred stocks are less risky than common

stock

Disadvantages Investing in Preferred Stocks

Return on preferred stocks is limited or fixed amount

Capital gains potential is small Yield give-up relative to bondYields have not always kept up with inflation

Valuation of Preferred Stock

Price = Annual Dividend Income (D) Prevailing Market Yield (K)