Investment Analyst Week 1

What does owning common stock actually mean?

You own a fractional ownership interest in a company. Common shareholders typically have voting rights and a residual claim on the company's assets and earnings after creditors and preferred shareholders are paid. The company may distribute some of its earnings to shareholders through dividends but dividends are not guaranteed.

Why does a stock have economic value?

A stock has economic value because ownership of the company gives shareholders a claim on the future economic benefits generated by the business such as future cash flows earnings and distributions. The market price is determined by supply and demand based on what investors collectively believe that future value is worth.

What is the difference between price and value?

Price is the amount investors are currently willing to pay or accept for a share in the market. It is determined by supply and demand. Value is an investor's estimate of what the business is fundamentally worth based on expected future cash flows earnings growth profitability and risk. If price is above estimated value the stock may be overvalued. If price is below estimated value it may be undervalued.

What is investment risk?

Investment risk is the possibility that an investment will produce a worse outcome than expected. This can include losing capital experiencing volatility losing purchasing power or failing to meet the investor's financial objective.

What is the difference between risk tolerance and risk capacity?

Risk tolerance is an investor's psychological ability and willingness to withstand investment losses and volatility without making poor decisions. Risk capacity is the investor's financial ability to withstand losses without jeopardizing financial goals or lifestyle. Capacity depends on factors such as income assets liabilities liquidity needs and time horizon.

Why does diversification help?

Diversification reduces the impact that any one investment company sector or asset class can have on the overall portfolio. If one investment performs poorly other investments may offset some of the loss.

What risks cannot be diversified away?

Systematic or market risk cannot be eliminated through diversification because it affects many or most investments simultaneously. Examples include recessions broad market crashes inflation and major changes in interest rates.

Why can a good company be a bad investment?

A good company can be a bad investment if its stock price is too high relative to the company's underlying value and expected future performance. If investors have already priced in extremely high growth expectations the company can perform well while the stock still produces poor returns if it fails to exceed those expectations.

What determines an appropriate asset allocation?

Appropriate asset allocation is determined by factors such as the investor's financial goals time horizon risk capacity risk tolerance liquidity needs tax situation and overall financial circumstances.

What is total return?

Total return is the overall gain or loss from an investment including both changes in the investment's price and income received such as dividends or interest over a specific period.