Chapter 12 Part 2

INDUSTRY A group of companies producing similar products or services Example: Soda 

Coca Cola Pepsi Jones Soda Beverages (non-alcoholic)

INDUSTRY Beverages (alcoholic)

INDUSTRY  S E C T O R Beverages (non-alcoholic) Beverages (alcoholic) Consumer Non-Cyclical Sector not affected much by economy (ups & downs)

What Sector?? General Electric

INDUSTRY A group of companies producing similar products or services

S E C T O R A broad group of similar industries

Today’s Topics What is diversification? Difference between Revenue & Profits? Importance of Earnings Dividends vs. Retained Earnings Income Stock Growth Stock Earnings per Share (EPS) & Price/Earnings

Diversification Reducing risk by combining different investments whose prices aren’t likely to move in step with one another Technology Financial Services Capital Goods Sector Healthcare Sector Energy Sector

REVENUE (Sales) Receive $10 at the end of the day Is the $10 the person’s profit ???

REVENUE (Sales) The $10 is the lemonade stand’s revenue (sales) REVENUE – the total money a company receives from selling a product or service

REVENUE (Sales) REVENUE PROFITS =

PROFIT (Earnings) The amount by which a company’s revenue exceeds its costs R E V E N U E - C O S T S P R O F I T S

PROFIT (Earnings) R E V E N U E -- $ lemons, sugar, cups (costs) 6.00 =P R O F I T $ 4.00

NET INCOME A company’s profit after subtracting all costs and income taxes

The Uncommon Hen & the Common Stock MARIA PIO

The Uncommon Hen & the Common Stock

Questions ? 1.Buyers bid against one another because they were eager to become Pio’s owner. What benefits did they initially expect to receive by becoming the chicken’s owner?

Response ? By owning Pio, they expected to earn money by selling all of the hen’s future golden eggs. $ $ $ $ $ $

Questions ? 1.Why did buyers suddenly lose interest in becoming Pio’s owner?

Response ? When Pio stopped laying golden eggs Buyers realized they could NOT earn money by owning the hen and selling its valuable eggs

Questions ? 1.Investors buy stock because they want to become part owners of a business. What benefits do investors expect to receive by becoming owners of the business?

Response ? Expect to receive company’s future earnings (profits) –Dividends –Higher stock price (capital gain)

Questions ? What would happen to the price of a stock if investors suddenly expected a company’s earnings to be much higher in the future?

Response ? Investors would bid up the price of the company’s stock 

Questions ? What if suddenly they expected the company’s earnings to be much lower?

Response ? They would pay less for the stock It’s price will then fall 

What does this chart suggest is the driving force behind rising stock prices over the years?

Chart Driving force behind rising stock prices over time is rising profits or earnings

Lemonade Stand Example What if the lemonade stand’s costs add up to $12 Revenue  $10.00 Costs  L O S S 

L O S S The amount by which a company’s costs exceed its revenue

No company is guaranteed a profit It has to earn it Many companies end up losing money instead

Who bears a company’s loss?? The company’s owners -- –The stockholders

A Tale of Two Marts Kmart and Wal-Mart Kmart Sold everything for ¢  S.S. Kresge Company  sold stock to public to raise $  grew larger and opened Kmart  changed name to Kmart (earned all profits)

A Tale of Two Marts Wal-Mart Start of Wal-Mart  Became “Public”  1980’s - Opened Sam’s Club  nation’s largest retailer  1997 – largest employer in U.S. (DOW)  biggest business listed on Fortune 500

As earnings soared, so did it’s stock price

As earnings fell, so did it’s stock price In 2002, Kmart declared bankruptcy.

Kmart May 2003 – Kmart emerges from bankruptcy January 2004 – earned first profit November merged with Sears

Stock prices act as financial faucets in our economy Increasing stock price opens flow of $ to company Decreasing stock price slows flow of $ to company

Profits & Eggs

Dividends Part of profits paid out to shareholders as cash or additional stock

Retained Earnings Part of profit that companies keep to reinvest in the company –Buy new equipment, machinery, etc –Research and development

Dividends & Retained Earnings A portion of the company’s profit that is paid to shareholders Company sells ,000. {sales} --pays Expenses 7,500 {bills} --pays Taxes 500 NET INCOME ,000 {left over}

Dividends & Retained Earnings Net Income $2,000. (profit) 3 Options: a) Retain and invest b) Pay dividends to shareholders C) Retain portion + pay out portion

Tax on Profits  $.04 After tax  $.06 Before taxes  $.10

Dividends ~ $70 B Retained Earnings ~ $90 B Total after-tax profits ~ $160 B Dividends 2003 ~ $160B Retained Earnings 2003 ~ $290B Total 2003 ~ $450 B

Dividend Yield  1.50% $.40 / = $1.46

For over 40 years, the dividend yield on stocks has averaged 3.3%

Some investors want a stock with strong dividend yields because they want the steady income the dividends provide Hence, INCOME STOCKS

Many stocks offer small dividends, or no dividends at all These are usually smaller rapidly growing companies – they reinvest profits to help grow the business Shareholders hope to receive higher stock price increases

Growth stocks typically have above-average growth in earnings per share

Growth Stocks Usually have higher price/earnings ratios than the market in general Stock Price = $20 Earnings = $ 1 20 = 20 1

Growth Stocks The P/E shows how much you would have to pay for each dollar of the company’s latest earnings P/E will be higher if investors expect company’s profit to grow faster

Growth 1) Slowin Inc – slow growth expected 2) Growin Inc – phenomenal growth expected

P/E All P/E ratios are based on investors’ views of future earnings

1.51% 1.69% 3.12%.93%

(.20 x 4) / 25. =.032 = 3.2%

You want to buy a new car! Price ? $34,000.

ASSET Something of value that a company holds You have $20,000 to put down -- need a loan for the balance Your loan would be D E B T

LIABILITY A debt that a company owes and must repay in the future If your loan (liability) is $14,000., what is the $20,000?? (the part you own) E Q U I T Y

Ownership

BALANCE SHEET Summary of a company’s assets, liabilities, and equity Assets = Liabilities + Equity

ACCOUNTING A method of recording a company’s financial story and arranging the information in reports that make the information understandable

ACCOUNTS PAYABLE The amount a company owes to suppliers for products and services bought

ACCOUNTS RECEIVABLE The amount customers owe a company for its products or services

CURRENT ASSETS Things that a company owns and could sell for cash during the year

CURRENT LIABILITIES The amount of a company’s debts payable within a year

DEPRECIATION The decline in value of an asset from wear and tear over a period of time, such as one year

DIVIDEND Part of a company’s profit (earnings) that it pays as money or shares to stockholders

Earnings Per Share (EPS) A company’s profit or earnings divided equally among all the shares investors own. It is calculated by dividing total earnings by the number of shares outstanding.

ENTREPRENEUR Someone who starts, manages, and bears the risks of owning a business

Financial Statements A company’s balance sheet and income statement

NET INCOME PER SHARE A company’s profit or earnings divided equally among all the shares investors own. It is calculated by dividing total earnings by the number of shares outstanding

PROPRIETORSHIP A company owned and run by one individual who receives its profits or bears its losses