Stock Personal Finance

Stock: Ownership Shares in a Corporation When a company makes money (has positive earnings), it can do two things with that money (often a combination of these two things): Reinvest the earnings into the company (Retained earnings) Payout the earnings to the owners (the stockholders) as dividends Generally, as a stockholder, if the company has lots of great opportunities to earn a high rate of return on new projects, you want that company to reinvest its earnings in those projects and thus earn you a higher rate of return on the money than you could have earned elsewhere. But if the company does not have lots of great opportunities to earn a high rate of return on new projects – they have more cash than is needed for the new projects – you want them to pay out that money to you as a dividend so that you can reinvest it (or spend it) where you choose.

Dividends Dividends: Cash distributions from the corporation to the stockholders. Usually distributed quarterly. Many stocks (especially newer ones) don’t currently pay dividends. Most stocks that have been around for a long time pay dividends and try to keep those quarterly dividends constant or regularly growing. Dividends are never guaranteed and if a company encounters financial difficulties, it can (and often will) reduce or eliminate its dividend.

Market Value = Current Price of the stock What value does an investor gain from owning a stock? Dividends and Capital Gains A capital gain arises when you buy a stock at one price and sell it (sometime later) at a higher price. Of course, you have a capital loss if you sell it at a lower price than you bought it at.

What determines the price of a stock? Very simply, a stock is worth whatever someone is willing to pay for it at that moment and whatever someone is willing to sell it for at that moment. Investors who feel that the present value of the stock’s future dividends and capital gains are greater than its price are usually looking to buy the stock. Investors who feel that the present value of the stock’s future dividends and capital gains are less than its price are usually looking to sell the stock. However, some investors regularly buy stock without trying to figure out its future price and dividends because they have excess funds that they want to invest for the future.  Also, some stock-holders regularly sell stock without trying to figure out its future price and dividends because they need money to spend on things now.

Short Sale Short sale – borrowing shares of a stock, selling them, buying them back later, and returning them Why do a short sale? Because you expect the price of a stock to go down. Be careful though When you buy a stock, the most you can lose is how much you invested When you short a stock, there is no limit to how much you can lose On average, stocks go up If a stock pays a dividend while your short position is open, you must pay that dividend to the person you borrowed the shares from.

How are stocks different from bonds? With a corporate bond, you are lending money to the company With a stock, you are one of the owners of the company When a company makes money, the bondholders get paid first After paying the bondholders, if there is still money left, the stockholders get it all Companies must make the interest payments on their bonds or be forced into bankruptcy Companies do not have to make dividend payments to their stockholders Bondholders do not get a vote on any decisions the company makes Stockholders get to vote on many issues – most importantly, they get to vote for the Board of Directors who represent them hire all employees (including the CEO),

How are stocks different from bonds? For any elections, each share of stock gets one vote. So in reality, if you don’t own a lot of shares, your vote won’t count for a lot. But – presumably, you want the same thing the other shareholders want – a higher value for your shares. Preferred Stock: A hybrid between stock and a perpetual bond. Receives a fixed dividend, but generally has no voting rights. Priced as you would price a perpetuity.

Some Important Terms Market Cap = Market Capitalization = Shares outstanding times price per share. This is the size of the stock. It is how much you would have to pay if you could buy every share of stock at its current price. EPS = Earnings per share. How much money the company made in a quarter (or year) divided by the number of shares outstanding Growth Rate: What percentage rate a stock’s price has been (or is expected to) going up by P/E Ratio = Market Multiple = Stock’s Multiple. The stock’s current price per share divided by its EPS. It is a measure of how expensive or cheap a stock is. Growth stocks are generally expensive. Value stocks are generally cheap The most important rule in finance: Buy low and Sell high Dividend Yield = Annual dividend divided by current price per share (since dividends are paid quarterly and can change, there are different ways to calculate an annual dividend) Bid = Price someone is willing to pay to purchase some shares of the stock Ask = Price someone is willing to accept to sell some shares of the stock

Buying and Selling Stock Stocks are not purchased from the company (you don’t buy shares of Apple from Apple). They are purchased from someone else who already owns the shares. A stock broker is someone who helps you buy or sell shares of stock. It is extremely difficult to buy or sell shares of stock at a fair price without a broker or brokerage firm. Stocks are typically bought and sold on an exchange. The two major stock exchanges in the U.S. are the New York Stock Exchange and the Nasdaq exchange. A market order means that you want to buy (or sell) shares immediately at whatever the best available price is. You only need to specify how many shares you want to buy or sell. A limit order must specify how many shares you want to buy or sell (as with a market order), but you also specify the highest price you are willing to pay (for a limit buy order) or the lowest price you are willing to receive (for a limit sell order). With a limit order, if a trade is made, you know what price your order will be executed at, but there is no guarantee that anyone will want to trade with you at the price you specified. The New York and Nasdaq exchanges are open weekdays from 9:30 am till 4:00 pm. Eastern Time. Other, smaller U.S. exchanges are open around the clock but there is comparatively little trading on them.