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Common Stock Investments
Dhanashri Academy
Key Topics
Key topics include:long-term perspective;advantages and disadvantages;characteristics, new issues, stock quotations
and transaction costs; measures of common stock value;dividends;different kinds of common stock; anduses and strategies of common stock
investing.
Common StockRepresents ownership in a corporation and
allows investors to participate in the profitsStocks offer investors the opportunity to
shape an investment program to their individual needs
Stock ReturnsStock returns come mainly from capital
appreciationStock market returns have averaged about
12% per year over the past 50 years, but over 18% during the past decade
Advantages: Common StockPotential for high returns; no upper
limits. May provide current income return from
dividends.Shares are highly liquid and easily
transferred. Transaction costs are relatively low; on-
line trades can be very cheap. Low unit prices relative to other
securities.
Disadvantages: Common StockEarnings and performance are subject to
wide swings.
Selection of common stocks is complex. Current income is relatively low, compared
to bonds.
Publicly Traded StocksPublic offering
an offering to sell to the investing public a set number of shares of a firm's stock at a specified price
Rights offering an offering of a new issue of stock to existing
shareholders, who may purchase new shares in proportion to their current ownership position
Publicly Traded StocksStock spin-off
a conversion of one of a firm's subsidiaries to a stand-alone company by distribution of stock in that new company to existing shareholders
Stock splitsa maneuver in which a company increases
the number of shares outstanding by exchanging a specified number of new shares of stock for each outstanding share
Publicly Traded StocksTreasury stock
stock that has been sold and subsequently repurchased by the issuing firm
Classified common stockStock issued by a company in different
classes, each of which offers different privileges and benefits to its holders
Buying and Selling Stocks
The investor must be familiar with stock quotes
The investor must also consider transaction costs
Stock QuotesNYSE – New York Stock ExchangeAMEX – American Stock ExchangeNASDAQ
Published in a twelve-column format
Column Titles52 weeks Hi
highest price within past year, adjusted for stock splits if any
52 weeks Lo lowest price w/n past year
Stock name of company
Column Titles (2 of 5)Sym
ticker symbol; 1-3 characters on NYSE and AMEX; 4-5 on NASDAQ.
Div annual dividend
Column TitlesYld %
dividend yield based on current annual dividend divided by market price PE - price-earnings ratio based on most recent four quarters of earnings
Vol 100s number of shares traded yesterday (in 100s)
Column TitlesHi
highest price at which stock traded yesterdayLo
lowest price yesterday Close - closing price yesterday
Column TitlesClose
closing price yesterday Net Chg
change in price from close of previous day
Transaction Costsaverage 1-5% of value of transaction when
using a full-service broker
Odd-lot trades (less than 100 shares) carry an added cost called odd-lot differential
Transaction Costs (continued)Discount brokers can save an investor up
to 70% on commission
On-line trades can now cost less than $ 10 per trade
Measures of ValuePar value
the stated or face value (meaningless for investment purposes)
Book value the amount of shareholder equity in a
company; equals the amount of the firm's assets minus liabilities and preferred stock
Measures of Value (continued)Market value
the prevailing price of a security.Investment value
the amount that investors believe a security should be trading for, or what they think it's worth.
Dividends and Earnings per Share (EPS)The directors make the dividend decisions
based on several factors.Earnings per share (EPS) represents the
amount that is earned per shareEPS = (net profit after taxes - pfd
dividends)# shares outstanding
Dividends and Earnings per Share (EPS)Dividends are paid out of earnings, but do
not have to be paid even when the firm is profitable
Generally, however, higher EPS lead to higher dividends
Dividends (Important dates)Record date
date on which an investor must be a registered shareholder to be entitled to receive a dividend
Ex-dividend date 3 business days prior to the date of record;
determines if one is an official shareholder and thus eligible to receive a declared dividend
Payment date the actual date on which the company pays
the dividend
Cash Dividends and the Dividend YieldDividends are normally paid in cash,
although stock dividends are also common.
Cash dividends are current income, which can be expressed as the dividend yield.
Dividend yield = annual dividend per share market price per share
Dividend Payout Ratio (DPR)One measure of stability of the cash
dividend is the dividend payout ratio (DPR). DPR = dividend per share / current market
price per share.A high DPR could suggest difficulty in
paying future dividends.
Dividend Reinvestment Plans and Stock DividendsDividend reinvestment plans (DRIPs)
plans in which shareholders have cash dividends automatically reinvested into additional shares.
Stock dividend A dividend payment in the form of additional
shares of stock.
Market Classifications of Common StockBlue chip stocks
financially strong, high quality stocks with long and stable records of earnings and dividends.
Income stocks Have long and sustained records of paying
higher-than-average dividends. Growth stocks
experience high rates of growth in operations and earnings.
Market Classifications of Common StockSpeculative stocks
offer the potential for substantial price appreciation, usually because of some special situation, such as new management or the introduction of a promising new product.
Cyclical stocks Stocks whose earnings and overall market
performance are closely linked to the general state of the economy.
Market Classifications of Common StockDefensive stocks
tend to hold their own, and even do well, when the economy starts to falter.
Mid-cap stocks medium-sized stocks, generally with market
value of less than $3-4 billion, but more than $750 million.
Small-cap stocks have market value of less than $750 million,
and may offer above-average returns.
Foreign StocksForeign equity markets
outperform US markets in most years Investors can buy foreign stocks directly
Has many logistical problems American Depository Receipts (ADRs)
Backed by foreign securities held by US banks
Foreign StocksBoth direct purchase and ADRs
have usual risks associated with common stocks, plus the currency exchange rate risk that drastically can affect total return.
Total return in US$ = dividends + cap gains (losses) + (or) - changes in FOREX rates.
Investment StrategiesInvestment strategies can be employed to
satisfy one of three basic investment needs:
warehouse of value accumulation of capital and/or as a source of income
Buy-and-Hold Strategy and The High-Income ApproachThe most basic strategy is the buy-and-
hold. High-quality stocks are selected and held for
extended periods; a strategy popular with value-oriented investors.
The high-income approach uses common stocks for current income.
Since dividends mostly increase through time, the level of current income increases as well.
Quality Long-Term Growth and Aggressive Stock Management
Quality long-term growth a less conservative strategy. This strategy
relies on capital gains as the primary source of return.
Aggressive stock management uses quality issues to seek attractive rates of
return in a fully managed portfolio. has substantial risk and requires a
substantial amount of investor time.
Speculation and Short-Term TradingSpeculation and short-term trading
the highest risk strategy.investor seeks returns from capital gains
while holding the stock only a short period of time.
Using Investment StrategiesThe first three strategies go well with the
objective to use stocks as a warehouse of value
All five could be used to accumulate capitalThe high-income strategy fits best with the
objective of using stocks as a source of income
Popular Investment Strategies Some Popular Investment Strategies Include:
Growth Investing, which is investing in stocks with above average forecasts of earnings growth and high price/earnings ratios in expectation of higher returns.
Value Investing, which is investing in stock of companies that are out of favor with the market for some reason, as reflected by low price/earnings ratios and low prices compared to their fundamentals.
Sector Investing, which is an investing style based on the premise that certain industry sectors perform better during specific stages of the economic cycle.
Momentum Investing, which is an investing style that focuses on using relative stock price movement to determine when to buy and sell.