M8. 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.

EX.

Debt ratio = total debt / total assets

S-T(current). debt = current Liab and (L-T debt). (1,780,785(S-T) + 1,389,615(L-T)) / 4,931,444 =

L-T(fixed).debt = assets - equity. stocks / common shares (4,931,444(T.A) - 1,761,044(common sheeres)) / 4,931,444

64.29% financed with debt.

inventory turnovers = COGS / inventory. 1,762,721 / 388,947 = 4.53 times/year

ROE = Net income / total expenses. 471,916 / 1,761,044 = 26,8%

Financial Ratios Analysis

as inflation goes up, stocks go down.

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

Debt ratio = total debt / total assets

S-T(current). debt = current Liab and (L-T debt). (1,780,785(S-T) + 1,389,615(L-T)) / 4,931,444 =

L-T(fixed).debt = assets - equity. stocks / common shares (4,931,444(T.A) - 1,761,044(common sheeres)) / 4,931,444

64.29% financed with debt.

inventory turnovers = COGS / inventory. 1,762,721 / 388,947 = 4.53 times/year

ROE = Net income / total expenses. 471,916 / 1,761,044 = 26,8%

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

as CAD goes up, foreign investors hold more CAD, TSX go up, so CAD goes up (good for Canadians)

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.