1 Chapter 13 - Stock Purchase stock = buy part of company Returns from dividends and capital appreciation –Dividends – distribution of profits –Neither dividends nor appreciation guaranteed Why invest in stocks? –Over time, outperform other investments, provide diversification, and are liquid

2 Annual Rates of Return 1926 to 2000 Avg Ann Stand Risk Security Returns Dev Prem Small Co Stocks 17.3% 33.4% 13.4% Common Stock L-T Corp Bonds L-T Govt Bonds Med-term Govt US T-Bills Inflation

3 Terminology Limited liability – stockholder not liable for firm's debts Claim on income (after all expenses paid) but board decides to pay dividends Dividends – 75% pay, usually quarterly Voting rights – shareholders elect directors and approve changes in governing rules –Vote through proxies

4 Proxy Statement Proxy – gives instructions on how to vote your shares Annual meeting – elect some directors, appoint auditors; sometimes approve option plans, new shares, merger, etc Statement – discusses directors, executive comp, stock performance versus index

5 Terminology II Splits – new shares issued on pro rata basis –No economic impact Share repurchases returns funds to shareholder; accomplishes other objectives

6 Stock Indexes Measure general market performance –DJIA (30 companies), S&P 500 and others Bear market – falling prices; bull market rising prices Stock prices now decimalized; previously fractions of a dollar

7 Classifications Blue-chips Growth stocks Speculative issues Cyclical stocks Defensive stocks Large caps

8 Valuing Stocks Technical analysis – supply and demand; charts used to predict trends –Author: Little value, other strong believers Price/ earnings ratios –Price / EPS – forward and backward looking –Positive about prospects, have high P/E –Dividend yield – about 1.6%

9 Top-Down Analysis Economic  Industry  Fundamentals Economic Analysis Fiscal & Monetary, Other (inflation, etc) Industry as a whole: Growing? Competitive? Technology? Cyclical? Company Fundamentals - Performance and position in industry, results 

10 Discounted Dividend Valuation Present values all future dividends –Dividends – an infinite stream –Assumed to grow at constant rate forever –Need to estimate future dividends and investors' required rate Market value = Dividend Next Year Required rate less growth rate How can you value a non-dividend stock?

11 Why Stocks Fluctuate Interest rate changes –Inverse relation between rate change and price change –Rates rise, present value of dividend and price both fall Risk – more risky, price falls Outlook for company and economy.

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13 Common Sense Advice Don'ts when stocks tumble: –Don't make impulsive decisions –Don't ignore taxes –Don't listen to pundits –Don't count you losses because they are meaningless until you sell.

14 Strategies Dollar cost averaging – buy fixed amount at regular intervals Buy and hold – Why? –Can't time the market, minimizes broker fees Dividend Reinvestment Plans (DRIP's) –Dividends automatically reinvested in the stock –Taxed on dividend even if get no cash

15 Stocks and the 15 Principles #1. Risk-return tradeoff – stocks on the upper end of the risk/return line #3 Diversification reduces risk – find investments that don't move together #4 Not all risk is equal – can reduce company specific risk but not market risk #11 Time – long horizon, can take more risk. See Figure 13.7