Investing in Stocks
Stock - represents ownership in a corporation
A form of equity financing
Money from sale of shares does not have to be paid back
The stockholder may sell shares of stock to another investor
Types of stock
Common stock
Preferred stock
Features of Common Stock
Voting rights
Common stockholders elect members of the board of directors and approve major policy changes
Proxy voting
Classes of stock
Class B stocks: Ford Motor
Dual-class share structures common in media and technology companies
Dividends
No legal obligation to pay dividends
Dividends paid out of profits, and must be approved by the board of directors
Regular cash dividends usually paid quarterly
Residual claim
Last in line to share in remaining assets during liquidation
Dividend payment procedure
Cash dividend of $0.83
Declaration date - the date on which the firm announces it intends to pay a dividend
Ex-dividend date - shares start to trade without he dividend, thus “ex-dividend”
Record date - shareholders registered on this date will receive the dividend
Payment date - the date on which dividend checks are mailed to the shareholders
Stock Split
Stock split - issue of additional shares o the firm’s stockholders
No cash leaves the firm
The firm increases the number of shares outstanding
Example - if you own 100 shares and the company declared a 2-for-1 stock split, you would own 200 shares after the split
Stock price is reduced when the stock splits
Features of Preferred Stock
Does not generally carry voting rights
Preference over common stock in dividend payments and in liquidation
Dividend characteristics
Stated dividend that must be paid before dividends can be paid to common stockholders
Dividends are not a liability of the firm and can be deferred indefinitely
Most preferred dividends are cumulative - missed preferred dividends have to be paid before any common dividends can be paid
Evaluating Stocks
Market capitalization (market cap)
Price per share x number of shares outstanding
$420.12 × 7.4 billion = $3.12 trillion
The total market value of the company is a measure of firm size
Stocks can be classified as large-cap (>$10bln), mid-cap ($2-10blm) or small-cap ($300 mln-2bln)
Earnings per share (EPS) - the corporation’s after-tax income divided by the number of outstanding shares of common stock
Measure of the company’s profitability
Price-to-earnings (P/E) ration
Price per share/earnings per share
Measures how much investors are willing to pay for a dollar of the company’s earning's. A high P/E ratio pay indicate a growth stock. A low P/E ratio may indicate a value stock
Dividend yield = annual dividend/price
Income stocks - stocks that pay regular and often higher-than-average dividends
If you buy a share of stock, you can receive cash in two ways
The company pays dividends
You sell your share at a future date
Dollar and Percentage Returns
Total dollar return = income from investment + capital gain (loss) due to change in price
Total percentage return = total dollar return/purchase price
Total return = dividends/purchase price + selling price — purchase price/purchase
Dividend yield + capital gains yield
Example: Calculating Returns for
Microsoft
On October 17, 2023, you bought 100 shares of Microsoft stock at a
price of $335. One month later, Microsoft issued a dividend of $0.75
per share, and you sold your shares for $370.
• What is your dollar return?
– Dividends = 100 shares x $0.75 = $75
– Capital gains = 100 shares x ($370 – $335) = $3,500
– Total dollar return = $3,575
• What is your percentage return?
– Dividend yield = $0.75 / $335 = 0.22%
– Capital gains yield = ($370 – $335) / $335 = 10.45%
– Total percentage return = 0.22% + 10.45% = 10.67%
Evaluating stocks
Beta - compares volatility associated with a specific stock with the volatility of the stock market (peroxide for by an index such as the S&P 500)
Measure of market (systematic risk)
If B > 1, stock is riskier than the market
If B < 1, stock is less risky than the market
Cyclical stocks - follow the business cycle of advances and declines in the economy
Defensive stocks - remain stable during declines in the economy
Fundamental analysis
Stock valuation based of analysis of fundamentals such as the company’s earnings and dividends prospects, risk, macroeconomic and industry conditions
Technical analysis
Stock valuation based on analysis of historical price patterns
Buying and Selling Stocks
Primary market
Market where new issues of financial securities are sold to the public for the first time
IPO (initial public offering)
When a company sells stock to the public for the first time
Secondary market
Market for existing financial securities that are currently traded among investors
Securities exchange
Physical location where trading occurs
New York Stock Exchange (NYSE)
Over the counter (OTC) market
Electronic network of dealers who buy and sell stocks
NASDAQ
Brokerage firm
Full-service brokerage firms charge higher commissions than discount and online brokerage firms
Direct investment plan - purchase stock directly from a corporation without having to use an account executive or brokerage firm
Dividend reinvestment plan (DRIP) - allows you the option to reinvest your cash dividends to purchase stock of the corporation
Types of Orders
Market order - request to buy or sell stock at the current market value
Limit order - request to buy or sell a stock at a specified pricee or better
Stop-loss order (stop order) - request to sell a stock at the next available opportunity after its market price reaches a specified amount
Summary
Stocks represent an ownership stake in a company
Investors buy stocks for dividend income and price appreciation
Most investors use fundamental analysis to evaluate stocks
If the business is dissolved, preferred stockholders have the first claim to the corporation’s assets after creditors
A small amount of capitalization is called a(n) penny stock
price-earnings ratio - Corporation’s income per share of stock, giving investors an idea how much they are paying
2 for 1 stock split = 2 x the number of shares previously owned
blue chip - issued by a large, stable company; usually pays dividends
cyclical - follows the business cycle of advances and declines in the economy
defensive - remains stable during economic decline
growth - issued by a corporation that has the potential of earning profits above the average of firms in the economy
Total return - annual dollar amount of income as well as any increase or decrease in the original purchase price of the investment
Book value - deducting all liabilities from the corporation’s assets and dividing the remainder by the number of outstanding shares of common stock
Primary market - an investor purchases financial securities through an investment bank or other representative from the issuer of those securities
Firms is the commissions they charge when you buy or sell stock and other securities
Investors using the buy-and-hold technique can earn profits from an increase in stock value and from dividends