Investment in Equity

Learning Goals What is equity market What is common stock. and what is Preferred stock Type of common stock and Preferred stock Strategy and style in investing in common stock

Equity Investment Common Stock and Preferred Stock 2 types of rights Voting Right Right to vote Elect management of corporation Preemptive Right Right to keep proportionate ownership of the company Let common shareholders buy new shares of stock before non-stockholders

Other Rights of Common Stockholders Right to inspect the books and records of the company Privilege of receiving dividends as cash, stock or property Right to receive distributions of any remaining assets should the company go out of business

An Overview of Common Stock Represents ownership in a corporation Known as equity securities or equities representing ownership shares in a corporation Voting right No maturity date Characteristics of common stock Residual claim - claim on the assets of a firm that goes bankrupt. Receive the assets after all other creditors, bondholders and preferred shareholders Limited Liability – shareholders only lose their amount of investment and not their personal belongings

Common Stock Dividend May be paid in cash, stock or property Determines by Board of Directors Increases or reductions are depend on how well the company is performing Corporate or Market Factors is one of the factors in making a decision to pay out dividends

Types of Common Stock Dividend Cash Dividends are those that are paid out in cash form Stock Dividends are dividends paid out in the form of additional stock shares in the corporation, or shares of a subsidiary corporation Property Dividends are paid with assets owned by the issuing company

Types of Common Stocks Blue Chip Stocks: financially strong, high-quality stocks with long and stable records of earnings and dividends Companies are leaders in their industries Relatively lower risk due to financial stability of company Popular with investing public looking for steady growth potential, perhaps dividend income Provide shelter during unsettled markets Examples:

Income Stocks: stocks with long and sustained records of paying higher-than average dividends Good for investors looking for relatively safe and high level of current income Dividends tend to increase over time (unlike interest payments on bonds) Some companies pay high dividends because they offer limited growth potential More subject to interest rate risk Examples:

Growth Stocks: stocks that experience high rates of growth in operations and earnings Have sustained rate of growth in earnings above general market Investors expect higher price appreciation due to increasing earnings Riskier investment because price may fall if earnings growth cannot be maintained May include blue chip stocks as well as speculative stocks Typically pay little or no dividends Examples:

Tech Stocks: stocks representing the technology sector of the market Range from speculative stocks of small companies that have never shown a profit to blue chip stocks of large companies that are growth-oriented Potential for attractive returns Considerable risk and volatility Difficult to put value on due to erratic or no earnings Examples:

Speculative Stocks: stocks that offer potential for substantial price appreciation, usually due to some special situation such as a new product Companies lack sustained track record of business and financial success Earnings may be uncertain or highly unstable Potential for substantial price appreciation Stock price subject to wide swings up and down in value Examples:

Cyclical Stocks: stocks whose earnings and overall market performance are closely linked to the general state of the economy Stock price tends to move up and down with the business cycle Tend to do well when economy is growing, especially in early stages of economic recovery Tend to do poorly in slowing economy Best for investors willing to move in and out of market as economy changes Examples:

Defensive Stocks: stocks that tend to hold their value, and even do well, when the economy starts to falter Stock price remains stable or increases when general economy is slowing Products are staples that people use in good times and bad times, such as electricity, beverages, foods and drugs Gold stocks are a form of defensive stock Best for aggressive investors looking for “parking place” during slow economy Examples:

Mid-Cap Stocks: medium-sized companies with market capitalizations between $1 billion and $4 or $5 billion Provide opportunity for greater capital appreciation than Large-Cap stocks, but less price volatility than Small-Cap stocks Usually have long-term track records for profits and stock valuation “Baby Blues” offer same characteristics of Blue Chip stocks except size Examples:

Small-Cap Stocks: small companies with market capitalizations less than $1 billion Provide opportunity for above-average returns (or losses) Usually do not have a financial track record Earnings tend to grow in spurts and can have dramatic impact on stock price Usually not widely-traded; liquidity is an issue “Initial Public Offerings (IPOs) Examples:

Alternative Investment Strategies Buy-and-Hold Investors buy high-quality stocks and hold them for extended time periods Goal may be current income and/or capital gains Investors often add to existing stocks over time Very conservative approach; value-oriented

High Income Investors buy stocks that have high dividend yields Safety of principal and stability of income are primary goals May be preferable to bonds because dividends levels tend to increase over time Often used to provide to supplement other income, such as in retirement

Quality Long-Term Growth Investors buy high-quality growth stocks, mid-cap stocks and tech stocks Capital gains are primary goal Higher level of risk due to emphasis on capital gains Significant trading of stocks may occur over time Diversification is used to spread risk “Total Return Approach” is version that emphasizes both capital gains and high income

Aggressive Stock Management Investors buy high-quality growth stocks, blue chip stocks, mid-cap stocks, tech stocks and cyclical stocks Capital gains are primary goal High level of risk due to emphasis on capital gains Investors aggressively trade in and out of stocks, often holding for short periods Timing the market is key element Time consuming to manage

Speculation and Short-Term Trading Also called “day trading” Investors buy speculative stocks, small-cap stocks and tech stocks Capital gains are primary goal Highest level of risk due to emphasis on capital gains in short time period Investors aggressively trade in and out of stocks, often holding for extremely short periods Looking for “big score” on unknown stock Time consuming & high trading costs

Investment Styles Growth Investing is investing in stocks with above average forecasts of earnings growth and high price/earning ratios in expectation of higher return. Investors need to monitor both company’s performance and industry trend closely, because these stocks are sensitive to change. Riskier than other styles as they rise faster and fall faster. Strategies - focus on capital appreciation; quality long- term growth, aggressive stock management, and even speculation.

Value Investing focuses on companies that are out of favor with the market. Value investors buy stocks whose prices are low compared to their fundamentals Low price/earnings ratios, low price-to-book value ratios and high dividend yields Investors expect some particular action – new management, corporate take over, regulatory change, etc – to drive up the price. cyclical industries such as automobiles, chemicals, steel, financial services or real estate companies Use buy-hold strategy.

Sector Rotation Style Investors choose stocks in specific industry sectors that will do best depending on the current and projected stages of the business/economic cycle. Do not look at the fundamentals of individual companies but look at the economy as a whole and forecast for the future. Divide stocks into four broad sectors interest sensitive stocks, consumer durables, capital good manufacturers, defensive stocks Investors rotate from one type of stock to the next as the economy moves from one stage of the business cycle to the next. Strategies - aggressive stock management and even a bit of short-term trading.

Momentum Investing Rely heavily on technical analysis – focuses on using relative stock price movement to determine when to buy and sell rather than fundamental of underlying companies. aggressive stock management or speculation and short- term trading strategies.

Preferred Stock Represents ownership in a corporation Fixed dividends and a claim on a company's assets that is above that of common shareholders Issued with a RM100 par (face) value

Types of Preferred Stock Cumulative preferred stock - continuous claim to dividends. Any unpaid dividends accumulate until the corporation resumes paying them. Non-cumulative (straight) preferred - opposite of cumulative preferred: it doesn't confer a steady claim on dividends in the event of a dividend suspension Participating preferred - shareholders receive extra dividends over their nominal Convertible preferred - converted to a certain number of shares of common stock

Features of Preferred Stock Limited voting right When the company wants to merge with another When the company wants to liquidate a large portion of its assets When the company wants to issue new bonds or preferred stock Call provision the issuing company can repurchase the stock from the shareholders. As a way to eliminate dividends, thus increasing earnings for common shareholders.

Conversion To convert to a specified number of shares of the issuing company’s common stock. Adjustable-rate (floating-rate) preferred Preference (prior preferred) stock A cumulative provision

Advantages Investing in Preferred Stocks Preferred stocks offer high current income. Preferred stockholders generally receive higher rate of return than bondholders Small investors are encouraged by the low unit cost of preferred stocks. Preferred stocks are less risky than common stock

Disadvantages Investing in Preferred Stocks Return on preferred stocks is limited or fixed amount Capital gains potential is small Yield give-up relative to bond Yields have not always kept up with inflation

Valuation of Preferred Stock Price=Annual Dividend Income (D) Prevailing Market Yield (K)