San Jose Community College

San Jose, Malilipot, Albay

S.Y 2022-2023

Investment
and
Portfolio
Management
 Module 3: Investment in Stock

Cathy C. Balbin
Instructor

Stock Investment

Investing in stocks means buying shares of ownership in a public company. Those small shares
are known as the company’s stock, and by investing in that stock, you’re hoping the company
grows and performs well over time.
When that happens, your shares may become more valuable, and other investors may be willing
to buy them from you for more than you paid for them. That means you could earn a profit if
you decide to sell them.

How to invest in stocks in six steps

There is no one-size-fits-all method for how to invest in stocks, but this six-step process could
help you get started. First, figure out how hands-on you want to be, open an account, choose
between stocks and funds, set a budget, focus on the long-term, and finally, manage your
portfolio. 
1. Decide how you want to invest in the stock market
There are several ways to approach stock investing. Choose the option below that best
represents how you want to invest, and how hands-on you'd like to be in picking and choosing
the stocks you invest in.
A. "I'd like to choose stocks and stock funds on my own." Keep reading; this article breaks
down things hands-on investors need to know, including how to choose the right account for
your needs and how to compare stock investments.
B. "I'd like an expert to manage the process for me." You may be a good candidate for a
robo-advisor, a service that offers low-cost investment management. Virtually all of the major
brokerage firms and many independent advisors offer these services, which invest your money
for you based on your specific goals.
C. “I’d like to start investing in my employer’s 401(k).” This is one of the most common ways
for beginners to start investing.
In many ways, it teaches new investors some of the most proven investing methods: making
small contributions on a regular basis, focusing on the long-term and taking a hands-off
approach. Most 401(k)s offer a limited selection of stock mutual funds, but not access to
individual stocks.
2. Choose an investing account
Once you have a preference in mind, you're ready to shop for an investment account. For the
hands-on types, this usually means a brokerage account. For those who would like a little help,
opening an account through a robo-advisor is a sensible option. We break down both processes
below.
An important point: Both brokers and robo-advisors allow you to open an account with very
little money.
The DIY option: Opening a brokerage account
An online brokerage account likely offers your quickest and least expensive path to buying
stocks, funds and a variety of other investments. With a broker, you can open an individual
retirement account, also known as an IRA, or you can open a taxable brokerage account if you’re
already saving adequately for retirement in an employer 401(k) or another plan.

A robo-advisor offers the benefits of stock investing, but doesn't require its owner to do the
legwork required to pick individual investments. Robo-advisor services provide complete
investment management: These companies will ask you about your investing goals during the
onboarding process and then build you a portfolio designed to achieve those aims.
This may sound expensive, but the management fees here are generally a fraction of the cost of
what a human investment manager would charge: Most robo-advisors charge about 0.25% of
your account balance. And yes — you can also get an IRA at a robo-advisor if you wish.
One thing to note is that although robo-advisors are relatively inexpensive, read the fine print
and choose your provider carefully.
Some providers require a certain percentage of an account to be held in cash. The providers
generally pay very low interest on the cash position, which can be a major drag on performance
and may create an allocation that is not ideal for the investor. These required cash allocation
positions are sometimes more than 10%.
If you choose to open an account at a robo-advisor, you probably needn't read further in this
article — the rest is just for those DIY types.

3. Learn the difference between investing in stocks and funds

Going the DIY route? Don't worry. Stock investing doesn't have to be complicated. For most
people, stock market investing means choosing among these two investment types:

Stock mutual funds or exchange-traded funds. Mutual funds let you purchase small pieces of
many different stocks in a single transaction. Index funds and ETFs are a kind of mutual fund that
track an index; for example, a Standard & Poor’s 500 fund replicates that index by buying the
stock of the companies in it.
When you invest in a fund, you also own small pieces of each of those companies. You can put
several funds together to build a diversified portfolio. Note that stock mutual funds are also
sometimes called equity mutual funds.
Individual stocks. If you’re after a specific company, you can buy a single share or a few shares
as a way to dip your toe into the stock-trading waters. Building a diversified portfolio out of
many individual stocks is possible, but it takes a significant investment and research.
If you go this route, remember that individual stocks will have ups and downs. If you research a
company and choose to invest in it, think about why you picked that company in the first place if
jitters start to set in on a down day.
The upside of stock mutual funds is that they are inherently diversified, which lessens your risk.
For the vast majority of investors — particularly those who are investing their retirement savings
— a portfolio made up of mostly mutual funds is the clear choice.
But mutual funds are unlikely to rise in meteoric fashion as some individual stocks might. The
upside of individual stocks is that a wise pick can pay off handsomely, but the odds that any
individual stock will make you rich are exceedingly slim.

4. Set a budget for your stock market investment

New investors often have two questions in this step of the process:
How much money do I need to start investing in stocks? The amount of money you need to
buy an individual stock depends on how expensive the shares are. (Share prices can range from
just a few dollars to a few thousand dollars.)
If you want mutual funds and have a small budget, an exchange-traded fund (ETF) may be your
best bet. Mutual funds often have minimums of $1,000 or more, but ETFs trade like a stock,
which means you purchase them for a share price — in some cases, less than $100).
How much money should I invest in stocks? If you’re investing through funds — have we
mentioned this is the preference of most financial advisors? — you can allocate a fairly large
portion of your portfolio toward stock funds, especially if you have a long time horizon.
A 30-year-old investing for retirement might have 80% of their portfolio in stock funds; the rest
would be in bond funds. Individual stocks are another story. A general rule of thumb is to keep
these to a small portion of your investment portfolio.

5. Focus on investing for the long-term

Stock market investments have proven to be one of the best ways to grow long-term wealth.
Over several decades, the average stock market return is about 10% per year. However,
remember that’s just an average across the entire market — some years will be up, some down
and individual stocks will vary in their returns.
For long-term investors, the stock market is a good investment no matter what’s happening day-
to-day or year-to-year; it’s that long-term average they’re looking for.
The best thing to do after you start investing in stocks or mutual funds may be the hardest:
Don’t look at them. Unless you’re trying to beat the odds and succeed at day trading, it’s good to
avoid the habit of compulsively checking how your stocks are doing several times a day, every
day.

6. Manage your stock portfolio

While fretting over daily fluctuations won’t do much for your portfolio’s health — or your own —
there will of course be times when you’ll need to check in on your stocks or other investments.
If you follow the steps above to buy mutual funds and individual stocks over time, you’ll want to
revisit your portfolio a few times a year to make sure it’s still in line with your investment goals.
A few things to consider: If you’re approaching retirement, you may want to move some of your
stock investments over to more conservative fixed-income investments. If your portfolio is too
heavily weighted in one sector or industry, consider buying stocks or funds in a different sector
to build more diversification.
Finally, pay attention to geographic diversification, too. Vanguard recommends international
stocks make up as much as 40% of the stocks in your portfolio. You can purchase international
stock mutual funds to get this exposure.

Best stocks for beginners

The process of picking stocks can be overwhelming, especially for beginners. After all, there are
thousands of stocks listed on the major U.S. exchanges.
Stock investing is filled with intricate strategies and approaches, yet some of the most successful
investors have done little more than stick with stock market basics.
That generally means using funds for the bulk of your portfolio — Warren Buffett has famously
said a low-cost S&P 500 ETF is the best investment most Americans can make — and choosing
individual stocks only if you believe in the company’s potential for long-term growth.
The S&P 500 is an index consisting of about 500 of the largest publicly traded companies in the
U.S. Over the last 50 years, its average annual return has been more or less the same as that of
the market as a whole — about 10%.

Types of Stocks
Understanding different stock types can benefit your portfolio

When most people think of stocks, they typically think of publicly listed shares traded on
the stock exchange. However, it's important for investors to know the different types of stocks
available, understand their unique characteristics, and be able to determine when they may
represent a suitable investment. Below, we outline the various stock categories, aiming to take
the confusion out of differing stock classes on offer to investors.

KEY TAKEAWAYS

 Understanding different stock categories can help investors make more informed
investment decisions and reduce portfolio risk.
 Preferred stock gives holders regular dividend payments before dividends are issued to
common shareholders but doesn't provide voting rights.
 Income stocks provide regular income by distributing a company's profits, or excess
cash, through dividends that are higher than the market average.
 Blue-chip stocks are shares of well-established companies with a large market
capitalization.
 ESG stocks emphasize environmental protection, social justice, and ethical management
practices.

Common and Preferred Stock

Common stock—sometimes referred to as ordinary shares—represents partial ownership in a
company. This stock class entitles investors to generated profits, usually paid in dividends.
Common stockholders elect a company's board of directors and vote on corporate policies.
Holders of this stock class have rights to a company's assets in a liquidation event, but only
after preferred stock shareholders and other debt holders have been paid. Company founders
and employees typically receive common stock.

On the other hand, preferred stock, or preference shares, entitles the holder to regular dividend
payments before dividends are issued to common shareholders. As mentioned above,
preferred shareholders also get repaid first if the company dissolves or enters bankruptcy.
Preferred stock doesn't carry voting rights and suits investors seeking reliable passive income.1

Many companies offer both common and preferred stock. For example, Alphabet Inc.—
Google's parent company—lists Alphabet Inc. (GOOGL), its Class A common stock, and
Alphabet Inc. (GOOG), its preferred Class C stock.

Growth Stocks vs. Value Stocks

As their name suggests, growth stocks refer to equities expected to grow at a faster rate
compared to the broader market. Generally, growth stocks tend to outperform during times of
economic expansion and when interest rates are low. For instance, technology stocks have
significantly outperformed in recent years, fueled by a robust economy and access to cheap
funding. Investors can monitor growth stocks by following the themed exchange-traded fund
(ETF), the SPDR Portfolio S&P 500 Growth ETF (SPYG).2

Conversely, value stocks trade at a discount to what a company's performance might otherwise

indicate, typically having more attractive valuations than the broader market. Value stocks—
such as financial, healthcare, and energy names—tend to outperform during periods of
economic recovery, as they usually generate reliable income streams. Investors can track value
stocks by adding the SPDR Portfolio S&P 500 Value ETF (SPYV) to their watchlist.3

Growth stocks have outperformed value stocks by about 5.93% over the past 10 years.23

Income Stocks
Income stocks are equities that provide regular income by distributing a company's profits, or
excess cash, through dividends that are higher than the market average. Typically, these
stocks—think utilities—have lower volatility and less capital appreciation than growth stocks,
making them suitable for risk-averse investors who seek a regular income stream. Investors
can access income stocks through the Amplify High Income ETF (YYY).4

Blue-Chip Stocks
Blue-chip stocks are well-established companies that have a large market capitalization. They
have a long successful track record of generating dependable earnings and leading within their
industry or sector. Conservative investors may top-weight their portfolio with blue-chip stocks,
particularly in periods of uncertainty. Several examples of blue-chip stocks include computing
giant Microsoft Corporation (MSFT), fast-food leader McDonald's Corporation (MCD), and
energy bellwether Exxon Mobil Corporation (XOM).

Cyclical and Non-Cyclical Stocks

Cyclical stocks are directly affected by the economy's performance and typically follow
economic cycles of expansion, peak, recession, and recovery. They usually display more
volatility and outperform other stocks in times of economic strength when consumers have
more discretionary income. Examples of cyclical stocks include iPhone maker Apple Inc.
(AAPL) and sports gear giant Nike, Inc. (NKE). Investors can add cyclical stocks to their
portfolios by purchasing the Vanguard Consumer Discretionary ETF (VCR).5

On the other hand, non-cyclical stocks operate in "recession-proof" industries that tend to
perform reasonably well irrespective of the economy. Non-cyclical stocks usually outperform
cyclical stocks in an economic slowdown or downturn as demand for core products and
services remains relatively consistent. The Vanguard Consumer Staples ETF (VDC) provides
exposure to large-cap defensive stocks like personal care giant The Procter & Gamble
Company (PG), as well as beverage makers PepsiCo, Inc. (PEP) and The Coca-Cola Company
(KO).6

Defensive Stocks
Defensive stocks generally provide consistent returns in most economic conditions and stock
market environments. These companies typically sell essential products and services, such
as consumer staples, healthcare, and utilities. Defensive stocks may help protect a portfolio
from steep losses during a sell-off or bear market. A defensive stock may also be a value,
income, non-cyclical, or blue-chip stock. Telecommunications giant AT&T Inc. (T) and
healthcare multinational Cardinal Health, Inc. (CAH) are among the defensive stocks included
in the core holdings of the Invesco Defensive Equity ETF (DEF).7

 
Defensive stocks are less likely to face bankruptcy because of their ability to generate
consistent returns during periods of economic weakness.

IPO Stock
When a company goes public, it issues stock through an initial public offering (IPO). IPO stock
typically gets allocated at a discount before the company's stock lists on the stock exchange. It
may also have a vesting schedule to prevent investors from selling all of their shares when the
stock commences trading. Market commentators also use the term "IPO stocks" when referring
to recently listed stocks. Investors can monitor for upcoming IPOs through the Nasdaq
website.8

Penny Stocks
A penny stock is equity valued at less than $5 and is considered highly speculative. Although
some penny stocks trade on major exchanges, many trade through the OTCQB—a middle-
tier over-the-counter (OTC) market for U.S. stocks operated by OTC Markets Group.9

 Investors should consider using limit orders when placing buy and sell orders in penny stock,
as they often have a large spread between the bid and ask price.
Penny stocks shot to prominence in popular culture after the release of The Wolf of Wall Street,
a movie about a former stockbroker who operated a penny stock scam. Investors who want to
take a bet on penny stocks should look at the iShares Micro-Cap ETF (IWC).10

ESG Stocks
Environmental, social, and corporate governance (ESG) stocks emphasize environmental
protection, social justice, and ethical management practices. For instance, an ESG stock may
be a company that agrees to reduce its carbon emissions at a greater rate than national and
industry targets or one that manufactures equipment for renewable energy infrastructure.

ESG stocks have gained popularity with millennials in recent years—a socially conscious
generation who are more likely to invest in things they believe and support. Investors can
access ESG stocks by adding the Vanguard ESG U.S. Stock ETF (ESGV) to their portfolio.

The Bottom Line

Understanding the key differences between stock categories helps investors make better-
informed investment decisions and manage risk within their portfolios. As well as buying
different types of stocks directly, investors can gain cost-effective exposure to themed stock
types through ETFs.

Table 15.1 Definitions of Stocks and their Roles in a Portfolio

Definition Role

Growth stock Underestimated potential for growth. Expect a higher rate of return.

Value stock Undervalued by the market; underpriced. Expect a higher-than-average return.

Less volatility than the overall market and Expect the value to fall less than the market’s during a market
Defensive stock
less sensitive to market changes. decline.

Cyclical stock More volatility than the overall market and When the market rises, expect the price to rise at a higher
more sensitive to market changes. rate. When the market falls, expect the price to fall at a higher
 Definition Role

rate.

Speculative stock Overvalued by the market; overpriced. Expect the price to continue rising for a time before it falls.

Stock of a stable, well-established, large

Blue chip stock Expect stable returns.
cap company.

Widow-and-
A blue chip defensive stock. Expect a steady dividend.
orphan stock

Wallflower stock Overlooked and therefore underpriced. Expect the value to rise when the stock is “discovered.”

Low-priced stock of a small or micro cap

Penny stock Expect the value to rise if and when the company succeeds.
company.

What Is the Stock Market, What Does It Do, and How Does It Work?

What Is the Stock Market?

The term stock market refers to several exchanges in which shares of publicly held companies
are bought and sold. Such financial activities are conducted through formal exchanges and
via over-the-counter (OTC) marketplaces that operate under a defined set of regulations. 

Both “stock market” and “stock exchange” are often used interchangeably. Traders in the stock
market buy or sell shares on one or more of the stock exchanges that are part of the overall
stock market.

The leading U.S. stock exchanges include the New York Stock Exchange (NYSE) and
the Nasdaq.

KEY TAKEAWAYS

 Stock markets are venues where buyers and sellers meet to exchange equity shares of public
corporations.
 Stock markets are components of a free-market economy because they enable democratized
access to investor trading and exchange of capital.
 Stock markets create efficient price discovery and efficient dealing.
 The U.S. stock market is regulated by the Securities and Exchange Commission   (SEC) and local
regulatory bodies.

Understanding the Stock Market

The stock market allows buyers and sellers of securities to meet, interact, and transact. The
markets allow for price discovery for shares of corporations and serve as a barometer for the
overall economy. Buyers and sellers are assured of a fair price, high degree of liquidity, and
transparency as market participants compete in the open market.

A stock market is a regulated and controlled environment. In the United States, the main
regulators include the Securities and Exchange Commission (SEC) and the Financial Industry
Regulatory Authority (FINRA).21
The earliest stock markets issued and dealt in paper-based physical share certificates. Today,
stock markets operate electronically.

 
Though it is called a stock market, other securities, such as exchange-traded funds (ETFs) are
also traded in the stock market.

How the Stock Market Works

Stock markets provide a secure and regulated environment where market participants can
transact in shares and other eligible financial instruments with confidence, with zero to low
operational risk. Operating under the defined rules as stated by the regulator, the stock markets
act as primary markets and secondary markets.6

As a primary market, the stock market allows companies to issue and sell their shares to the
public for the first time through the process of an initial public offering (IPO). This activity helps
companies raise necessary capital from investors.

A company divides itself into several shares and sells some of those shares to the public at a
price per share.6 To facilitate this process, a company needs a marketplace where these
shares can be sold and this is achieved by the stock market. A listed company may also offer
new, additional shares through other offerings at a later stage, such as through rights
issues or follow-on offerings. They may even buy back or delist their shares.

Investors will own company shares in the expectation that share value will rise or that they will
receive dividend payments or both. The stock exchange acts as a facilitator for this capital-
raising process and receives a fee for its services from the company and its financial
partners.6Using the stock exchanges, investors can also buy and sell securities they already
own in what is called the secondary market.

The stock market or exchange maintains various market-level and sector-specific indicators,
like the S&P (Standard & Poor’s) 500 index and the Nasdaq 100 index, which provide a
measure to track the movement of the overall market.

 
Following an IPO, the stock exchange serves as a trading platform for buying and selling the
outstanding shares. This constitutes the secondary market. The stock exchange earns a fee for
every trade that occurs on its platform during secondary market activity.6

What Are the Functions of a Stock Market?

The stock market ensures price transparency, liquidity, price discovery, and fair dealings in
trading activities.

The stock market guarantees all interested market participants have access to data for all buy
and sell orders, thereby helping in the fair and transparent pricing of securities. The market also
ensures efficient matching of appropriate buy and sell orders.7

Stock markets need to support price discovery where the price of any stock is determined
collectively by all of its buyers and sellers. Those qualified and willing to trade should get
instant access to place orders and the market ensures that the orders are executed at a fair
price.

Traders on the stock market include market makers, investors, traders, speculators, and

hedgers. An investor may buy stocks and hold them for the long term, while a trader may enter
and exit a position within seconds. A market maker provides necessary liquidity in the market,
while a hedger may trade in derivatives.

How Stock Markets Are Regulated

Most nations have a stock market, and each is regulated by a local financial regulator or
monetary authority, or institute. The SEC is the regulatory body charged with overseeing the
U.S. stock market.

The SEC is a federal agency that works independently of the government and without political
pressure. The mission of the SEC is stated as “protecting investors, maintaining fair, orderly,
and efficient markets, and facilitating capital formation.”8

Companies listed on the stock market exchanges are regulated, and their dealings are
monitored by the SEC. In addition, the exchanges set certain requirements such as mandating
timely filing of quarterly financial reports and instant reporting of relevant corporate
developments, to ensure that all market participants are equally informed.

Failure to adhere to the regulations can lead to suspension of trading and other disciplinary
measures.

What Is the Significance of the Stock Market?

The stock market is a component of a free-market economy. It allows companies to raise
money by offering stock shares and corporate bonds and allows investors to participate in the
financial achievements of the companies, make profits through capital gains, and earn income
through dividends. The stock market works as a platform through which savings and
investments of individuals are efficiently channeled into productive investment opportunities and
add to the capital formation and economic growth of the country.

What Is an Alternate Trading System?

Alternative trading systems are venues for matching large buy and sell transactions and are not
regulated like exchanges. Dark pools and many cryptocurrency exchanges are private
exchanges or forums for securities and currency trading and operate within private groups.

Who Helps an Investor Trade on the Stock Market?

Stockbrokers act as intermediaries between the stock exchanges and the investors by buying
and selling stocks and portfolio managers are professionals who invest portfolios, or collections
of securities, for clients. Investment bankers represent companies in various capacities, such
as private companies that want to go public via an IPO or companies that are involved in
pending mergers and acquisitions.

How the Stock Market Affects GDP

The stock market is often a sentiment indicator and can impact gross domestic product (GDP).
GDP measures the output of all goods and services in an economy. As the stock market rises
and falls, so too, does sentiment in the economy. As sentiment changes, so do people's
spending, which ultimately drives GDP growth; however, the stock market can have both
negative and positive effects on GDP.
KEY TAKEAWAYS

 The stock market is often a sentiment indicator that can impact gross domestic product (GDP) either
negatively or positively.
 In a bull market—stock prices are rising—consumers and companies have more wealth and
confidence—leading to more spending and higher GDP.
 In a bear market—stock prices are falling—consumers and companies have less wealth and
optimism—leading to less spending and lower GDP.

Understanding How the Stock Market Affects GDP

Before we can determine how the markets impact GDP, we must first review what drives
growth in an economy. The U.S. economy's GDP is primarily driven by spending and
investment.1 GDP is typically shown as a percentage growth rate from one period to another.

For example, the quarter-to-quarter growth rate might be 2%, meaning the U.S. economy grew
by 2% in that quarter on an annualized basis. Below are a few of the key components that
make up GDP:

 Consumer spending; which is the primary driver for GDP in the U.S.
 Business spending includes purchases of new plants and equipment, hiring, investing in
new technologies, and building new offices and factories.
 Exports are sales from domestic companies to customers internationally.
 Government spending includes building roads, bridges, and subsidies for industries, such
as agriculture.