Chapter 14: Investing in Stocks and Bonds

Stocks and Bonds and How They are Used Common stock Preferred stock Bonds

Investing in Stocks Why do corporations issue common stock? Equity financing To raise money to start, expand or help pay for ongoing business expenses They don’t have to repay the money Dividends are not mandatory Stockholders have voting rights-proxy

Why Do Investors Purchase Stock? Income from dividends Dollar appreciation of stock value (averaged 10% since 1926). Increased value from stock splits

Percentage of People in Different Age Groups That Own Stocks

Income from Dividends Dividends can be paid in: Cash Additional stock Company products Who is entitled to the dividends? Record Date Ex-dividend Date

Dollar Appreciation of Stock Value 100 shares of common stock purchases January 5, 2007 and were sold January 5,2010; total dividends of $4.97 per share for the four years. Cost when purchased Total investment $5,735 Return when sold 100 shares @$57 = $5,700 100 shares @$71 = $7,100 Plus commission + 35 Minus commission -35 Total return $7,065 Transaction summary Total return $7,065 Minus total investment - 5,735 Profit from stock sale $1,330 Plus dividends +497 Total return from the transaction $1,827

Stock Split 2:1 3:1 3:2 Firm’s management usually has a theoretical stock price range for the firm’s stock.

Common vs. Preferred Stock Common stock get dividends depending on profit the company makes Preferred stock receive cash dividends before common stock holders pre-determined dividend rate most preferred stock is callable

Features of Preferred Stock Cumulative preferred stock unpaid cash dividends accumulate and are paid before cash dividends to common stock holders Conversion feature can be traded for shares of common stock

Characteristics of Common Stock Blue Chip Small Cap Cyclical Micro Cap Defensive Penny Stock Growth Income Large Cap Mid Cap

Language of Stock Investing Earnings per share (EPS) After tax earnings divided by the number of outstanding shares of common stock. Price/earnings ratio (P/E ratio) Price of a share of stock divided by the corporation’s EPS. Dividend payout ratio Annual dividend amount divided by EPS Historical information

Language of Stock Investing Price/Earnings to Growth Ratio: A Look to the Future Step 1: Determine the projected change Step 2: Use the PEG formula PEG = Price earnings ratio divided by annual EPS growth.

Language of Stock Investing Look at book value of one share net worth of company divided by the number of outstanding shares if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development

Buying and Selling Stocks Primary market Initial Public Offering (IPO) Secondary market Security Exchange New York Stock Exchange Regional Exchange Over the Counter Market Nasdaq

Brokerage Firms Full Service Discount Online

Completing Stock Transactions Market Order Limit Order Stop Order Day Order, Week Order, Month Order or Good Until Canceled (GTC) Order

Long-Term Investment Strategies But-and-Hold Dollar Cost Averaging Direct Investment Dividend Reinvestment Plan (DRIP)

Short-Term Techniques Day Trading Buying on Margin Selling Short Trading in Options

Make a Decision to Sell Stocks 1. Stock reaches target price. 2. Favorable development temporarily push up price. 3. Good profits unlikely to continue. 4. Stock lags behind others in industry group. 5. Company profits begin to fall short of projections. 6. Industry/company prospects are deteriorating. 7. Losses are moderate. 8. Stock’s price/earnings ratio appears too high.

Language of Bond Investing Registered and bearer Callable Warrants Convertibility

Language of Bond Investing Indenture Face value, coupon rate, maturity date Secured and unsecured Senior and subordinated

Types of Bonds Corporate bonds U.S. government securities Treasury bills, notes, and bonds Federal agency issues Municipal Bonds

Considerations Before Investing in Bonds Susceptibility to certain risks Credit Callability Inflation Interest rate

Considerations Before Investing in Bonds Premiums and discounts Current yield Yield to maturity Tax-equivalent yields When to sell

Formula 14.2

Formula 14.3

Advantages of Investing in Bonds Pay higher interest rates than savings Offer safe return of principle Have less volatility than stocks Offer regular income Require smaller initial investment

Disadvantages of Investing in Bonds No hedge against inflation Can be quite volatile Compounding is almost impossible Subject to investors tax rate Poor marketability