12-1 Chapter 12 Investing in Stocks Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

12-2 Investing in Stocks Chapter Learning Objectives LO12.1Identify the most important features of common and preferred stock. LO12.2Explain how you can evaluate stock investments. LO12.3Analyze the numerical measures that cause a stock to increase or decrease in value. LO12.4Describe how stocks are bought and sold. LO12.5Explain the trading techniques used by long- term investors and short-term speculators.

12-3 Learning Objective LO12.1 Identify the Most Important Features of Common and Preferred Stocks Common and Preferred Stocks Two concerns for beginning investors –Where to get the information –What the information means

12-4 Common Stock = most basic form of corporate ownership Stock = equity financing Reasons why corporations issue Stock –Raise money to start or expand business –Pay ongoing business expenses –Need not repay the money –Dividends not mandatory Board of Directors votes on each dividend payment But: –Shareholders have voting rights and elect the board of directors Why Corporations Issue Common Stock

12-5 Investors can make money in three ways –Income from dividends Cash Stock dividend –Dollar appreciation of stock value Price appreciation Capital gain –Possible increased value from stock splits No guarantee price will go up after a split Why Investors Purchase Common Stock

12-6 Dividend Dates Declaration date = Board of Directors votes to pay a dividend Record date = a stockholder must be registered on the firm’s books to receive the dividend Ex-Dividend date = 2 nd business day before the record date stock begins to trade without the dividend –Investors buying after the ex-div date do not receive the dividend Payment date = dividend is paid

12-7 Preferred Stock A middle investment between common stock (equity) and corporate bonds (debt) –Stockholders know the amount of cash dividend when the stock is purchased –Conservative equity position like common stock but usually non-voting Dividends paid before common stock –Dividend may be omitted by action of the board

12-8 Learning Objective LO12.2 Evaluating a Stock Issue

12-9 The Internet –Firm’s home page more current than printed materials Look for “Investor Relations” link – Research on a company Stock screener to help choose investments Professional advisory services

12-10 Where Can You Find a Stock Quote, and What Does One Look Like? Print sources –The Wall Street Journal –The local newspaper Online sources: – – – – – – –

12-11 First enter stock symbol Resulting screen Common Stock Price Quotes Online at

12-12 Common Stock Price Quotes Last trade price = $75.43 Annual dividend = $1.76 P/E =  Earnings per share = 75.43/14.13 = $5.34

12-13 E valuating a Stock Issue Stock Advisory Services Research materials = more detailed information compared to other sources of information Most charge a fee Three most popular: –Standard and Poor’s reports –Value Line –Mergent’s Handbook of Nasdaq Stocks

12-14 Corporate News Prospectus lists all necessary information as dictated by the Federal government All publicly traded corporations send their stockholders an annual report Securities and Exchange Commission website ( Business periodicals: –Bloomberg Businessweek, Fortune, Forbes, Money, Kiplinger’s Personal Finance Magazine

12-15 Learning Objective LO12.3 Numerical Measures that Influence Investment Decisions Corporate earnings –One of the most significant factors in changes in the value of a stock Earnings per share (EPS) –Corporation’s earnings divided by the number of outstanding shares of common stock –EPS Increase = generally a healthy sign

12-16 Numerical Measures That Influence Investment Decisions Price-earnings ratio (PE) –Price per share of stock divided by the firm’s earnings per share –How much an investor is paying for a company’s earning power –P/E > 20  investor optimism –P/E < 20  lower earnings expectations –Compare to firms in same industry Projected Earnings –EPS and PE based on historical data –Future expectations more relevant

12-17 Other Factors that Influence the Price of a Stock Dividend yield –Annual dollar dividend divided by current price per share –Dividend yield increase = healthy sign Total return –Dividends plus capital gains –Cash income + Price appreciation Book value per share –(Assets – Liabilities) divided by Number of shares –Market price per share is often > book value

12-18 Other Factors that Influence the Price of a Stock Predicting the future value of a share of stock uses the Time Value of Money concepts from Chapter 1. The price an investor is willing to pay is determined by: –Expected future dividends –Potential increase in price –A combination of the first two Stock market bubble –Stocks are trading above their actual worth –Driven by investor optimism and irrational expectations –Bubbles “burst”

12-19 Learning Objective LO12.4 Buying and Selling Stocks Primary Market Investor buys securities from issuer of those securities via an investment bank –Investment bank = financial firm that assists corporations in raising funds, usually by helping sell new security issues (underwriting) IPO = when a corporation sells stock to the general public for the first time Key factor: Cash from security sales goes to issuing company

12-20 Buying and Selling Stocks Secondary Market Market for existing financial securities Traded among investors via brokers and dealers Markets –Securities exchanges –Over-the-counter markets

12-21 Securities Exchanges (NYSE) Securities exchange = Marketplace where members, representing investors, meet to buy and sell securities Securities sold on an exchange must be listed, or accepted for trading, on that exchange “A Listed Market” = NYSE Designated “Specialists” –Buy or sell a particular stock –Responsibility for maintaining a fair and orderly market

12-22 The Over-the-Counter (OTC) Market (NASDAQ) Network of dealers who buy and sell the stocks of companies from inventory –Dealer = “Market Maker” NASDAQ = electronic marketplace for approximately 3,600 companies

12-23 Brokerage Firms and Account Executives Account executive (stockbroker) –Licensed individual who buys and sells securities for his or her clients Churning –Excessive buying and selling of securities to generate commissions –Illegal under SEC regulations

12-24 Discount vs. Full Service Brokers Service vs. Cost How much advice do you want? Can you buy and sell stocks over the phone Can you trade stocks online? Where is the nearest office located? Toll-free number for customer use? How often are statements issued? Is there a charge for statements, research reports, and other financial reports? Are there any fees in addition to the commissions to buy and sell?

12-25 Computerized Transactions Reasons that justify trading online 1.Size of investment portfolio 2.Ability and desire to manage own portfolio 3.Ability to monitor investments closely 4.Capability of computer and software

12-26 Stock Transaction Orders Market order –Order to buy or sell stock at the current market value Limit order –Order to buy or sell a stock at a specified price Stop-loss order –Order to sell a stock at the next available opportunity after its market price reaches a specified amount

12-27 Commission Charges Brokerage minimum commissions –Range = $5 to $25 –Depends on the number of shares traded and stock value Full service vs. discount brokers –Full service fees > Discount broker fees –Online broker  little advice and you make your own decisions

12-28 Learning Objective LO12.5 Long-Term and Short-Term Investment Strategies Long-Term Investment Strategies Buy and hold Dollar cost averaging Direct investment and dividend reinvestment plans (DRIPS) – –

12-29 Dollar Cost Averaging Long-term technique Invest equal dollar amount in the same stock at equal intervals Goals: –Minimize average cost per share –Avoid “Buy High – Sell Low”

12-30 Short-Term Investment Strategies Buying stock on margin –Borrowing money from broker –Margin requirement set by the Fed –“Bullish” Selling short –Borrowing stock –“Sell high, buy low” –“Bearish”

12-31 Short-Term Investment Strategies Trading in options –Option = the right but not the obligation to buy or sell a stock at a predetermined price during a specified period of time Call option –Right to buy –“Bullish” Put option –Right to sell –“Bearish” –Not for amateurs or beginning investors

12-32 Chapter Summary Learning Objective LO12.1 Corporations sell stock (a form of equity) to finance their business start-up costs and help pay ongoing business costs. Common stockholders have the right to elect the board of directors. They must also approve major changes to corporate policies. Possible reasons for stock investments include: –Dividend income –Appreciation of value –The possibility of gain through stock splits A few corporations may issue preferred stock. –Preferred stockholders receive cash dividends before any cash dividends are paid to common stockholders –Dividend distributions to both preferred and common stockholders must be approved by the board of directors

12-33 Chapter Summary Learning Objective LO12.2 Start the stock evaluation process with the classification of different types of stock investments ranging from very conservative to very speculative—see Exhibit 12–3. Information for stock evaluation is available from: –The internet –Stock advisory services –The newspaper –The corporations that issue stocks –Business and personal finance periodicals –Government publications

12-34 Chapter Summary Learning Objective LO12.3 Many analysts believe that a corporation’s ability or inability to generate earnings in the future may be one of the most significant factors that account for an increase or decrease in the value of a stock. –Generally, higher earnings equate to higher stock value, and lower earnings equate to lower stock value. Earnings per share and a price-earnings ratio are historical numbers based on what a corporation has already done.

12-35 Chapter Summary Learning Objective LO12.3 Investors can obtain earnings estimates for most corporations. Other calculations that help evaluate stock investments include: –Dividend yield –Total return –Book value Stock prices are also affected by: –The amount of future dividends –A potential increase in the price of a share of stock –What another investor will pay for a share of stock

12-36 Chapter Summary Learning Objective LO12.4 A corporation may sell a new stock issue with the help of an investment banking firm. Once the stock has been sold in the primary market (IPO), it can be sold time and again in the secondary market. –In the secondary market, investors purchase stock listed on a securities exchange or traded in the over-the-counter market. Securities transactions are made through: –An account executive who works for a full-service brokerage firm –A discount brokerage firm –Online brokerage firm

12-37 Chapter Summary Learning Objective LO12.4 Basic order types include: –Market order –Limit order –Stop-loss order Brokerage firms typically charge a minimum commission for buying or selling stock. Additional commission charges are based on: –The number of shares bought or sold –The value of the shares –You can use a full-service or discount brokerage firm or trade online.

12-38 Chapter Summary Learning Objective LO12.5 Purchased stock may be classified as either a long-term investment or a speculative investment. Long-term investors typically hold their investments for at least a year or longer. Techniques long-term investors use include: –Buy-and-hold –Dollar cost averaging –Direct investment plans –Dividend reinvestment plans

12-39 Chapter Summary Learning Objective LO12.5 Speculators (sometimes referred to as traders) usually sell their investments within a shorter time period Techniques they use include: –Buying on margin –Selling short –Trading in options