LEARNING MODULE #3

INVESTMENT AND PORTFOLIO MANAGEMENT

Chapter III- Investment in Stocks

In more advanced countries, stock investment is an indispensable source of income for both the
private sector and the government. In the Philippines, there has been a general misconception about
stock investment perhaps because of lack of adequate information and its non-inclusion in the
educational curricula. Although stocks are just one of the investment vehicles, some management books
generally refer to stocks when it comes to investments.

Stock investment Defined

Stock investment refers to acquisition of shares of stocks of other corporations to realize profit
upon their sale and for periodic income (in the form of dividends)
A share of stocks is a unit of ownership in a corporation so that stock investment is in effect an
investment in a portion of the equity in a corporation. Thus, it is generally in the form of common stock
which carries with it the right to vote and to share in corporate earnings after providing for preferred
stock.

Classifications of stock
1. Based on Rights of Stockholders
a. Common stock – this represents the basic ownership in a corporation. It carries with it the
right to vote on corporate matters, shares in profits after providing for the shares preferred
stock therein, and absorbs corporate losses before any portion thereof is charged to
preferred stock. The percentage of ownership in a corporation is measured based on
common shares owned.
b. Preferred stock – this refers to that portion of owners’ equity that enjoys preferences over
common stock. These may be in the distribution of earnings and/or distributions of assets in
case of liquidation. Preferred stock as to dividends may be further classified into cumulative,
participating, and cumulative and participating.

2. Based on Risk and Earnings Potential

a. Blue Chips – these belong to large companies which have a long record of the earnings and
dividend payments. These are also known as value stocks. Although returns are moderate,
they are low risk and are dependable. Examples are San Miguel Corp., PLDT, MERALCO and
Ayala Corp. investment in this kind of stocks is called value investment.
b. Growth Stock – these belong to corporations with growth rate faster than that of the
general economy. The growth may be in terms of revenue, net income and productive
assets.
c. Cyclical Stock - their earnings and prices move with the changes in the national economy.
Examples are those corporations engaged in high-cost real estate (Ayala Land Corp.)
 d. Defensive Stocks – their earnings are not affected so much by changes in the economy.
They belong to corporations engaged in foods and public utilities. Examples are Jollibee
Corp., Globe Telecom, MERALCO etc.
e. Speculative Stocks – these belong to companies that are not yet operating profitably but are
expected to do so in the future.
3. Based on their marketability
In relation to marketability of stocks, they are classified as listed or unlisted depending on
whether they are listed in the stock exchange or not.
4. Based on citizenship of investors
Stocks are classified into Class A and Class B. Class A may be bought by the Filipinos only.
Foreign investors are allowed to buy Class B only due to the prohibition for the
foreigners to fully own equity in a Philippine corporation.

Stock Values
Stocks have par value, book value, net asset value, and market value per share. Par value is
the nominal value assigned to a share as appearing on the stock certificate. It is the minimum amount at
which share of stock may be originally issued.
Book value is the value of stock based on the value of stockholder’s equity per book accounts.
The stockholders’ equity per books is equal to asset at book value minus liabilities. The book value
therefore does not reflect the current value of a stock because most of the assets per accounting
records are stated at historical cost.
Net asset value of a stock is based on the current value of asset minus liabilities.
Market value of a stock is its current market price. It is the closing price in the day-to-day
trading in the stock exchange. It is affected by supply and demand and goes up and down depending on
the market situations as affected by economic, political and corporate developments.

Parties Involved in Stock Investment

The Stock Market

Stock market is where the stocks are bought and sold. These may be done in the stock exchange
or in the over-the-counter market.
Stock Exchange is an organization that facilitates the trading of stocks, warrants and other
securities listed therein. As defined in the Revised Security Act(RSA) an exchange is an organized
marketplace or facility that brings together buyers and sellers and executes trades of securities and/or
commodities.
The members of the exchange are stock brokers who elect from among themselves the
members of its board of governors. Brokers converge on the trading floor every trading day to accept
buy or sell orders from their clients. Nowadays, with the computerization of its system and using
technology, brokers are able to participate in the trading activities even from their offices. Securities
that are listed in the stock exchange are called publicly listed securities and must have conformed to
criteria as promulgated by its board of governors.
Role of the Stock Exchange in the Economy
The stock exchange plays a major role in an economy. A well-managed stock exchange benefits
the economy as follows:
1. It increases foreign investments because foreign or global investors are encouraged to
invest in listed profitable corporations.
2. It enables business entities to raise additional capital.
3. It provides the government with additional revenue by collecting sales tax in a stock
exchange.
4. It gives Filipinos more faith in their future because of the investment vehicles a stock
exchange provides and also because of the combined effect of the above given advantages
from having a reliable stock exchange.

Over-the Counter Market

Over the counter (OTC) market refers to trading of securities that are not listed in the stock
exchange. The securities traded are usually those of corporations that are relatively new, those
intending to concentrate their ownership to relatively few stockholders, corporations that have not yet
qualified for public listing and those that are making their initial public offering (IPO) through the
brokers.

Stockbroker and Stock Dealer

Stockbroker is an individual or company duly licensed by the SEC to participate in trading in the
stock exchange. He should have adequate understanding of securities, financial statements, periodic
reports, and basic economic theory. A stockbroker earns commissions on all “buy” and “sell” orders
done.
Stock dealer is one who buys and sells stock for his own account. He may be a stockbroker or
one who trades through a stockbroker. His gain or loss from his stock trading depends on his ability in
choosing the stocks to buy and in determining when to sell them.

Clearing House
The clearing house is the entity wherein interbroker payments and transfers of stocks are
coursed through so that each broker does not have to deal directly with all the others.

Price Volatility
The volatility of prices refers to the speed at which prices go up and down. The more volatile the
market is, the bigger the potential profits and losses on the short term. An aggressive stock trader would
buy on “lows” and sell on “highs” while a conservative investor would prefer to hold on to his shares as
long-term investment.

Price Band
Price band refers to the range within which the price of a stock may change in one day’s trading.
Why Prices Fluctuate
Prices fluctuate in a stock market because their behavior is affected by supply and demand .
When a stock price has gone up significantly, investors resort to “profit taking” and then wait for the
prices to go down so they can repurchase the stock at lower prices
Oversold and Overbought. When the price of a stock has gone down so low, they are said to
be oversold so that it is time to buy. The lowest the price at which seller is willing to sell or at which
there would be more buyers than sellers is called the price support. In cases wherein the price has
gone up or has reached an all-time high, the stock is considered as overbought so that it would be
advisable to sell particular stock or to refrain from buying it. When stock price gone up to the extent
that sellers outnumbers buyers, there is said to be a price resistance and prices tend to go down.

Price support refers to the lowest price that a stock can command while price resistance refers
to the highest price that a stock can command.

The Domino Effect

The domino effect as observed in stock investment refers to the similar price behavior of others
stocks as brought about by the price behavior of another.

Bullish and Bearish Markets

The term bullish is derived from the coarse and forceful characteristics of a bull. A market is
said to be bullish when prices increasingly move upwards. In other words, despite some technical
corrections arising from profit taking, technical rallies result in higher resistance.
The term bearish is based on the rude and surly characteristics of a bear. In a bearish market,
prices are dropping continuously. There may be technical rallies from time to time but both prices
resistance and support continuously decline.

Stock Splits
Stock splits are changes in par value of corporate stock bringing about the corresponding
changes in the number of shares outstanding and market value per share. It may be split-up or split-
down (reverse split). Split-up refers to a reduction in par value per share to bring about an increase in
the number of outstanding shares and the proportionate decrease in the market value per share. Split-
Down (or Reverse Split) refers to raising the par value per share and consequently reduces the
number of shares outstanding and raises the market value per share. It is undertaken when
corporation’s stock has ceased being speculative or when it intends to reduce the number of smaller
shareholders.

Stop Loss Order

Stop loss order refers to an investor’s order to sell his shares if prices go below a certain level
in order to minimize his loss. This is done when prices are going down at a very fast rate and therefore
expected to go down further.
Buying on margin
Buying on margin means that an investor buys stocks but does not fully pay for them. The
amount of liability he incurs is called margin. This practice is undertaken to earn more in case the market
price of the particular stocks bought goes up. It is very risky because in case the market price goes down,
the investor’s capital can easily be wiped out. In extreme case, he may even become insolvent.

Bases in Investing in Stocks

A. Investing based on technical analysis. Trading is based on price trends and the attitude of
investors toward a specific stock. The investor keeps track of price changes and may even go
to the extent of using graphs. He buys at the “lows” and sells at the “highs”.
B. Investing based on fundamental analysis. This is also called value investing because it is
based on the value of the underlying corporation which is measured in terms of book of
value, net asset value, earnings per share and price earnings per ratio.
Minimizing Risk in Stock Investments
A. Do your homework. This means that you should conduct research on the stock of your
choice, watch TV business programs, read annual reports and business sections of
newspapers, and make inquiries. Your broker may be in position to give additional
information on said stocks. Doing your homework would enable you to refrain from trading
based on rumors.
B. Diversify our stock investments. it is advisable to spread the investable funds in stocks
among five to seven kinds so that losses in some can somehow be offset by gains in others
and at the same time enable you to keep track of corporate development in each. Spreading
investable funds thinly is not advisable because it would not enable you to realize significant
profit in each and keep track of the developments in each of the corporations involved.
C. Beating the Market. You should buy at the point of most pessimism and sell at the point of
most optimism. This is called contrarian investing. It has often been said that stock
investment is more of being aware as to when price have reached rock bottom.
D. Avoid trading on margin. When you trade on margin, you are under pressure to sell even if
the prices are going down because there is a liability to settle. On the other hand, if you do
not have liability to liquidate from the proceeds, you can hold on to your investment until
 prices have improved and then sell at a gain. Trading on margin can eliminate one’s capital
and even cause of bankruptcy.
E. Know when it is advisable to cut losses. Cutting losses as taken up earlier means selling
even at a loss during times when price are continuously declining. You should not hesitate to
sell even at a loss if the price of particular stock that you have expected to go down further.
This would enable you to conserve part of your capital and use it when another opportunity
presents itself. The saying “opportunity knocks only once” does not apply in stock
investments. on the contrary, there are so many opportunities therein if only we can be
aware when they present themselves.
F. Remain Focused on long-term objectives. Stock investment requires long-term perspective.
Although you may buy and sell based on price fluctuation, the core portion of the total
investment must be in stocks the prices of which are expected to rise in the long-run. There
are stocks that are favorites of local traders and there are those that are preferred by
foreign investors.
Despite all of the precautions, an investor commits mistakes. But then, even the
veterans in stock trading do so. What is important is that the investor learns from his
mistakes and tries to improve his hitting average. Have the courage. Invest.