Investing in Stocks - Summary

Common and Preferred Stocks

• Common Stock:
  • Basic form of corporate ownership.
  • Equity financing: Money from selling ownership shares.
  • Dividends are not mandatory (30-70% of earnings).
  • Stockholders have voting rights.
• Why investors purchase common stock:
  • Potential for larger returns.
  • Income from dividends: Payments from profits, consider the record date and ex-dividend implications.
  • Dollar appreciation: Profit from selling stock at a higher price.
  • Stock Splits: Shares divided into a larger number, lowers stock price to attract investors.
• Preferred Stock:
  • Receive dividends before common stockholders.
  • A middle investment (between common stock and bonds).
  • Dividends are more secure but less secure than interest on corporate bonds.

Evaluating Stock Investments

• Stock Classifications:
  • Blue chip, large cap, cyclical, midcap, defensive, small cap, growth, micro cap, income, penny stock.
• Information Sources:
  • Corporate websites, financial websites (Yahoo Finance), stock advisory services (Standard & Poor’s, Value Line, Morningstar).
  • Newspapers, SEC filings, annual reports.

Numerical Measures

• Earnings Per Share (EPS):
  • \text{EPS} = \frac{\text{After-tax income}}{\text{Number of shares outstanding}}
  • Increase in earnings is a positive sign.
• Price-Earnings (P-E) Ratio:
  • \text{P-E ratio} = \frac{\text{Price per share}}{\text{Earnings per share}}
• Dividend Payout:
  • \text{Dividend payout} = \frac{\text{Annual dividend amount}}{\text{Earnings per share}}
• Dividend Yield:
  • \text{Dividend yield} = \frac{\text{Annual dividend amount}}{\text{Price per share}}
• Total Return:
  • \text{Total return} = \text{Dividends} + \text{Capital gain}
• Annualized Holding Period Yield:
  • \text{Annualized holding period yield} = (\frac{\text{Total return}}{\text{Original investment}})^{\frac{1}{N}} - 1
    • Where N = Number of years investment is held
• Beta:
  • Volatility compared to an index (e.g., S&P 500).
  • \text{Volatility for a stock} = \text{Increase in overall market} \times \text{Beta for a specific stock}
• Book Value Per Share:
  • \text{Book value per share} = \frac{\text{Assets – Liabilities}}{\text{Shares Outstanding}}
• Market-to-Book Ratio:
  • \text{Market-to-Book Ratio} = \frac{\text{Market value per share}}{\text{Book value per share}}

Investment Theories

• Fundamental Analysis:
  • Stock value based on future earnings, financial strength, industry, and economic growth.
• Technical Analysis:
  • Stock value based on market supply and demand, past trends predict future direction.
• Efficient Market Hypothesis:
  • Stock prices are random and reflect true value, outperforming the market is impossible without increased risk.

Buying and Selling Stocks

• Primary Market:
  • New securities purchased from the issuer through an investment bank.
  • Initial Public Offering (IPO): First time a corporation sells stock to the public.
• Secondary Market:
  • Existing securities traded among investors.
  • Securities Exchanges: Marketplaces for buying and selling listed securities.
  • Over-the-Counter (OTC) Market: Network of dealers for stocks not on exchanges (e.g., Nasdaq).
• Account Executives (Stockbrokers):
  • Licensed individuals who buy/sell securities for clients.
• Order Types:
  • Market Order: Buy/sell at current market value.
  • Limit Order: Buy/sell at a specified price or better.
  • Stop-Loss Order: Sell when price reaches a specified amount.

Investment Strategies

• Long-Term Techniques:
  • Buy-and-Hold.
  • Dollar Cost Averaging.
  • Direct Investment and Dividend Reinvestment Plans.
• Short-Term Techniques:
  • Day Trading.
  • Buying Stock on Margin (borrowing money).
  • Selling Short (borrowing stock).
  • Trading in Options (predetermined price).