Module 8 Investing in Stocks

Investing in Stocks

Module 8

Objectives

• Analyze a stock value

• Execute the purchase or sale of stocks

• Assess your stock portfolio’s performance

Stock Exchanges

• Definition: Facilities allowing investors to buy/sell existing stocks; a stock must be listed to be traded.

• Major Exchanges in Canada:

  • Toronto Stock Exchange (TSX): trades senior equities

  • TSX Venture Exchange: public venture capital

  • Montreal Exchange: derivatives exchange

  • NYSE and NASDAQ.

Stock Listings and Trading

• To be listed on TSX, firms must meet minimum requirements in:

  • Revenue

  • Cash flow

  • Net tangible assets

  • Working capital

• Electronic Trading:

  • Major exchanges provide electronic trading services.

  • Market Makers: Securities dealers who maintain liquidity by trading actively.

Stock Quotations

• Where to Find Stock Quotes:

  • Online platforms (MarketWatch, Yahoo! Finance)

  • Stockbrokers

  • Financial newspapers (National Post, Globe & Mail)

  • TV networks (BNN, Bloomberg)

• Example of a Stock Quote: Closing Price, Volume, Bid, Ask (e.g., Yahoo Finance)

Buying or Selling Stocks

Selecting a Broker

• Full-service Broker: Provides investment advice; may suggest frequent trading.

• Discount Brokerage Firm: Executes transactions without providing advice.

• Brokerage Commissions:

  • Full-service brokers charge between 3%-8%.

Order Types

• Market Order: Buys/sells at prevailing market price.

  • Advantage: Quick execution.

  • Disadvantage: Price may change before execution.

• Limit Order: Buy/sell only if the price meets specified limits.

Example Transactions

• Royal Bank of Canada (RY) Stock Example:

  • Market order for 100 shares at $132.

  • Limit orders for various prices ($140, $120, $100, $150).

Buying on Margin

• Definition: Buying stock with borrowed funds plus personal investment; minimum margin requirement = 30%.

• Margin Call: Request by brokerage to increase cash in the account if the value of the investment declines.

• Example:

  • Buying 500 shares at $20; computations for margin and price fluctuation effects.

Evaluating a Firm

Key Factors

• Financial Performance

• Company Track Record

• Business Costs

• Leadership

• Risk Factors

• Dividend History

Financial Analysis

• Company's Disclosure Document:

  • Annual reports provide CEO messages, performance summaries, and financial statements.

• Key Financial Statements:

  • Balance Sheet: Assets, Liabilities, and Shareholders' Equity.

  • Income Statement: Measures revenues, expenses, and earnings over periods.

Sample Financial Statements

Statement of Financial Position (Balance Sheet)

• 2021 vs 2020 data for items like cash, accounts payable (A/P), accounts receivable (A/R), and total assets.

Statement of Comprehensive Income

• Example: Financial data displaying revenues, cost of goods sold, expenses, and net income for 2021.

Financial Ratios Analysis

Categories

• Liquidity: Ability to cover expenses (Current Ratio).

• Financial Leverage: Ability to make debt payments (Debt Ratio, Times Interest Earned Ratio).

• Efficiency: Use of assets (Inventory Turnover, Total Asset Turnover).

• Profitability: Net profit margin, Return on Assets (ROA), Return on Equity (ROE).

Ratios Formulas

Liquidity

• Current Ratio = Current Assets / Current Liabilities

Financial Leverage

• Debt Ratio = Total Debt / Total Assets

• Times Interest Earned = EBIT / Interest

Efficiency

• Inventory Turnover = Cost of Goods Sold / Inventory

• Total Asset Turnover = Sales / Total Assets

Profitability

• Net Profit Margin = Net Income / Sales

• Return on Assets = Net Income / Total Assets

• Return on Equity = Net Income / Total Equity

Ethics in Investing

Accounting Fraud

• Motivations: Stock price influences manager compensation; financial performance focus leads to unethical practices.

• Techniques: Revenue recognition before earnings are realized.

• Preventive Measures: Sarbanes-Oxley Act aims to restore investor confidence.

Factors Affecting Stock Prices

• Economic factors like interest rates, economic outlook, inflation, political shocks, and currency value fluctuations.

Stock Valuation

• Value stocks using technical or fundamental analysis.

  • Technical Analysis: Valuation based on historical price patterns.

  • Fundamental Analysis: Based on revenue and firm performance.

Dividend Discount Model (DDM)

• DDM: Values stocks based on future dividend payments discounted at the required return.

  • Limitations: Non-stable dividends, growth rate unpredictability.

Price-Earnings (P/E) Method

• P/E Ratio: Relationship between earnings per share (EPS) and stock price.

• Limitations: Difficulty in forecasting earnings; variable results across industries.

Assessing Stocks Performance

• Calculate rate of return

• Measure against benchmarks like S&P indices.

Summary

• Stocks are traded on exchanges with quotes providing performance data.

• Analyze liquidity, leverage, efficiency, and profitability before investing.

• Various methods like DDM and ratio analysis assist in stock valuation based on particular methods.