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Common Stock Basics
Common Stock Basics
1. Definition: Stocks are A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. 2. Types: Common Stock (usually entitles the owner to vote at shareholders' meetings and to receive dividends). Preferred (generally does not have voting rights, but has a higher claim on assets and earnings than the common shares). Class A: A classification of common stock that may be accompanied by more voting rights. Class B: a classification of common stock that usually does not have as many or may not have any voting rights to elect officers to the Board of Directors of a Corporation. 3. Represents OWNERSHIP in the Corporation.
Calculated as:
The payout ratio provides an idea of how well earnings support the dividend payments. More mature companies tend to have a higher payout ratio.
Where: D = Expected dividend per share one year from now k = Required rate of return for equity investor G = Growth rate in dividends (in perpetuity)
The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas).
- Inflation has averaged approximately 5.4% during the same time period.
LT Bonds
11.3% 10.6% 8.2% 6.8% 5.8%
LT Govt Bonds
11.9% 10.4% 7.9% 6.4% 5.3%
T. Bills
5.6% 7.3% 6.7% 5.7% 5.7%
CPI
3.5% 5.2% 5.4% 4.5% 4.4%
Source: Ibbotson and Sinquefield, Stocks, Bonds, Bills and Inflation 2007 yearbook, Chicago.
The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The "Big Board" was founded over 200 years ago in 1792 with the signing of the Buttonwood Agreement by 24 New York City stockbrokers and merchants. Currently the NYSE, with stocks like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and Wal-mart, is the market of choice for the largest companies in America.
Columns 1 & 2: 52-Week High and Low - These are the highest and lowest prices at which a stock has traded over the previous 52 weeks (one year). This typically does not include the previous day's trading. Column 3: Company Name & Type of Stock - This column lists the name of the company. If there are no special symbols or letters following the name, it is common stock. Different symbols imply different classes of shares. For example, "pf" means the shares are preferred stock. Column 4: Ticker Symbol - This is the unique alphabetic name which identifies the stock. If you watch financial TV, you have seen the ticker tape move across the screen, quoting the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don't know what a particular company's ticker is you can search for it at: http://finance.yahoo.com/.
Column 5: Dividend Per Share - This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends. Column 6: Dividend Yield - The percentage return on the dividend. Calculated as annual dividends per share divided by price per share. Column 7: Price/Earnings Ratio - This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial. Column 8: Trading Volume - This figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add "00" to the end of the number listed. Column 9 & 10: Day High and Low - This indicates the price range at which the stock has traded at throughout the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.
Column 12: Net Change - This is the dollar value change in the stock price from the previous day's closing price. When you hear about a stock being "up for the day," it means the net change was positive.
Quotes on the Internet Nowadays, it's far more convenient for most to get stock quotes off the Internet. This method is superior because most sites update throughout the day and give you more information, news, charting, research, etc.
Bear Markets characterize the attitude of investors who believes that a particular security or market is headed downward. Bears attempt to profit from a decline in prices. Bears are generally pessimistic about the state of a given market. Bearish sentiment can be applied to all types of markets including commodity markets, stock markets and the bond market.
Investing in Equities
Common Stock Investments
A. Basic Characteristics
1. Equity Capital 2. Types
a. b. c. d. e. Growth Stock Income Stock Speculative Stock Cyclical Stock Defensive Stock
The Father of Fundamental Analysis: Benjamin Graham Who was Benjamin Graham?
Fundamental Analysis: A method of evaluating a
security factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and individually specific factors (like the financial condition and management of companies).
Sources:
Security Analysis (Graham and Dodd); The Intelligent Investor (Graham)
Terms
1. Net Current Assets (NCA)
Defined as:
Current Assets - Current Liabilities - Long-Term Debt - Preferred Stock NCA Total
Terms (continued)
2. Data Source
S&P Stock Guide Value Line, etc.
3. 4. 5. 6. 7.
Earnings Per Share (EPS) Market Price Book Value Per Share Dividends Per Share Current Ratio
Terms (continued)
8. Total Debt 9. Equity 10. Growth
1/n
Contemporary Fundamentals:
Peter Lynchs Ten Golden Rules of Investing:
1. 2. 3. 4. 5. 6. Dont be intimidated by experts (ex spurts). Look in your own backyard. Dont buy something you cant illustrate with a crayon. Make sure you have the stomach for stocks. Avoid hot stocks in hot industries. Owning stocks is like having children. Do not have more than you can handle. 7. Dont even try to predict the future. 8. Avoid weekend worrying. Do not get scared out of good stocks. Own your mind. 9. Never invest in a company without first understanding its finances. 10. Do not expect too much, too soon. Think long-term.
Contemporary Fundamentals:
Peter Lynchs mistakes to avoid:
1. Thinking that this year will be any different than any other year 2. Becoming too concerned over whether the stock market is going up or down 3. Trying to time the market 4. Not knowing the story behind the company in which you are buying stock 5. Buying stocks for the short-term
Contemporary Fundamentals:
Lynch Maxims:
1. A good company usually increases its dividends every year. 2. You can lose money in a very short time, but it takes a long time to make money. 3. The stock market isnt a gamble as long as you pick good companies that you think will do well and not just because of the stock price. 4. You have to research the company before you put money into it.
Templetons 16 Rules
9. Aggressively monitor your investments. 10. Dont panic. Sometimes you wont have everything sold as the market crashes. Once the market has crashed, dont sell unless you find another more attractive undervalued stock to buy. 11. Learn from your mistakes, but do not dwell on them. 12. Begin with prayer, you will think more clearly. 13. Outperforming the market is a difficult task, you must outthink the managers of the largest institutions. 14. Success is a process of continually seeking answers to new questions. 15. There is no free lunch. Do not invest on sentiment. Never invest in an IPO. Never invest on a tip. Run the numbers and research the quality of management. 16. Do not be fearful or negative too often. For 100 years optimists have carried the day in U.S. Stocks.
Investing in Equities
Technical Analysis
A. Definition
Technical analysis really just studies supply and demand in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor. Technical Analysis is the belief that90 important information about future 80 70 stock price movements can be 60 obtained by studying the historical 50 40 30 price movement.
20 10 0 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Assumptions
1. The Market Discounts Everything
technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors. Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.
Assumptions
2. Price Moves in Trends
In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.
Assumptions
3. History Tends To Repeat Itself
Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.
4. 5.
6.
Trading Days
Closing Prices
Trading Days