Personal Finance Sixth Edition Investing in Stocks PDF

Personal Finance SIXTH EDITION Chapter 15 Investing in Stocks Copyright © 2017, 2014, 2011 Pearson Education, Inc. Al...

Personal Finance SIXTH EDITION Chapter 15 Investing in Stocks Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Chapter Objectives 15.1 Identify the functions of stock exchanges 15.2 Describe how to interpret stock quotations 15.3 Explain how to execute the purchase and sale of stocks 15.4 Explain how to analyze a stock Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Why Corporations Issue Common Stock Common Stock = most basic form of corporate ownership Stock = equity financing Reasons why corporations issue stock: – Raise money to start or expand business – Pay ongoing business expenses – Need not repay the money – Dividends not mandatory ▪ Board of Directors votes on each dividend payment. But: – Shareholders have voting rights and elect the board of directors. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-4 The Psychology of Stock Investing Three important facts: 1. While the almost 10 percent average annual return on stock investments described above is enticing, keep in mind that the value of stocks can also decrease. 2. There is risk when you invest in stocks. 3. The key to success is allowing your investments to work for you over a long period of time. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Why Companies Issue Common Stock Common stock is the most basic form of ownership for a corporation. Corporate managers prefer selling common stock as a method of financing for several reasons: – A Form of Equity ▪ Equity financing is money received from the owners or from the sale of shares of ownership in a business. – Dividends Not Mandatory ▪ A dividend is a distribution of money, stock, or other property that a corporation pays to stockholders. – Voting Rights and Control of the Company ▪ A proxy is a legal form that lists the issues to be decided at a stockholders’ meeting and requests that stockholders transfer their voting rights to some individual or individuals. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Stock Exchanges (1 of 4) Stock exchanges: facilities that allow investors to purchase or sell existing stocks Dubai Financial Market – One of the organized exchange in UAE – Floor traders: traders at a stock exchange who execute trades to fulfill orders placed by other investors Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-7 Why Investors Purchase Common Stock Investors can make money in two ways: – Income from dividends ▪ Cash ▪ Stock dividend – Dollar appreciation of stock value ▪ Price appreciation ▪ Capital gain Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Stock Exchanges (2 of 4) – Specialists: traders who help to make a market in one or more stocks by taking the position opposite of orders placed by clients – A typical stock transaction on the DFM is submitted through a brokerage firm and executed by a specialist Other stock exchanges – Abu Dhabi stock exchange – Other regional exchanges in large GCC countries Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Stock Exchanges (3 of 4) Over-the-counter (OTC) market: an electronic communications network that allows investors to buy or sell securities – Market makers: traders who execute trades on the OTC market and earn commissions in the form of a bid-ask spread – Some stock exchanges have less stringent listing requirements Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Stock Quotations (1 of 2) Price quotations readily available from the Internet, stock brokers or financial newspapers Provide information about the price of each stock over the previous day or a recent period Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Stock Quotations (2 of 2) EXHIBIT 15.1 Example of a Daily Stock Quotation 52-Week Hi Lo Stock (Div.) Yield (%) PE Vol. (100s) Close Net Change 62.10 49.40 Zugle ($1.00) Zugle ($1.00) 14 9000 50.00 +.27 Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (1 of 7) Selecting a broker – Analyst recommendations ▪ May be overly optimistic ▪ Must disclose ownership of stocks they recommend – Individual broker skills ▪ Information available on the Internet Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (2 of 7) – Brokerage commissions ▪ Discount brokerage firm: a brokerage firm that executes your desired transactions but does not offer investment advice ▪ Full-service brokerage firm: a brokerage firm that offers investment advice and executes transactions Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (3 of 7) Placing an order – Name of the stock ▪ Ticker symbol: the abbreviated term that is used to identify a stock for trading purposes – Buy or Sell—specify what you want to do – Number of shares ▪ Round lot: shares bought or sold in multiples of 100 ▪ Odd lot: less than 100 shares of stock Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (4 of 7) – Market order or limit order ▪ Market order: an order to buy or sell a stock at its prevailing market price ▪ Limit order: an order to buy or sell a stock only if the price is within the limits that you specify – Stop orders ▪ Stop order: an order to execute a transaction when the stock price reaches a specified level; a special form of limit order Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (5 of 7) – Stop orders ▪ Buy stop order: an order for a brokerage firm to buy a stock when the price rises to a specified level ▪ Sell stop order: an order for a brokerage firm to sell a stock when the price falls to a specified level Placing on order online – Low commission Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (6 of 7) Buying stock on margin – On margin: purchasing a stock with a portion of the funds borrowed from a brokerage firm – Federal Reserve limits margin to 50 percent – Margin call: a request from a brokerage firm for the investor to increase the cash in the account in order to bring the margin back up to the minimum level Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Purchasing and Selling Stocks (7 of 7) Short selling stock – Short selling (shorting): a process by which investors sell a stock that they do not own – Borrow stock from another investor and will have to return it – Investor hopefully sells high and buys low (in that order) Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Some vidoes WE THE ECONOMY | What are some important things to know about the stock market? - Greg Ip https://www.youtube.com/watch?v=IFi5k7Lvtyw Michael Burry Predicts Another Market Crash. Here’s His Full Stock Portfolio https://www.youtube.com/watch?v=HP8QDvjJoV8 &feature=youtu.be Ep. 10: THE STREET | Joe Berlinger https://www.youtube.com/watch?v=mlGnQ6LJPgw Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (1 of 11) Technical analysis: the valuation of stocks based on historical price patterns Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (2 of 11) Analyzing a firm’s financial condition – Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time – Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (3 of 11) Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (4 of 11) – Accounting fraud ▪ In the early 2000s many firms used fraudulent financial statements ▪ Enron and WorldCom are the most prominent examples ▪ Motivation for fraud – Manager compensation Analyzing economic conditions – Economic growth: a measure of growth in a country’s economy over a particular period Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (5 of 11) – Gross domestic product (GDP): the total market value of all products and services produced in a country – Fiscal policy: the means by which the U.S. government imposes taxes on individuals and corporations and by which it spends its money – Impact of international economies ▪ One country’s strong economy can improve another’s and the opposite is also true Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (6 of 11) – Interest rates ▪ Stocks perform better when interest rates are low ▪ Some stocks are more sensitive to interest rates than others ▪ The Federal Reserve uses monetary policy to influence interest rates ▪ Monetary policy – policy established by the Federal Reserve to adjust the supply of funds in the financial system in order to influence interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (7 of 11) – Inflation: the increase in the general level of prices of products and services over a specified period ▪ Consumer price index (CPI): a measure of inflation that represents prices of consumer products such as groceries, household products, housing and gasoline ▪ Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products, such as coal, lumber, and metals Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (8 of 11) EXHIBIT 15.3 Sources of Economic Information Published Sources ▪ Federal Reserve Bulletin: provides data on economic conditions, including interest rates, unemployment rates, inflation rates, and the money supply. ▪ Federal Reserve District Bank publications: provide information on national and regional economic conditions. ▪ Survey of Current Business: provides data on various indicators of economic activity, including national income, production levels, and employment levels. Online Sources ▪ Bloomberg (http://www.bloomberg.com): provides reports on interest rates, other economic conditions, and news announcements about various economic indicators. ▪ Federal Reserve Meeting Information is also available online at http://www.federalreserve.gov. ▪ Federal Reserve District Bank publications are also online at http://www.frbsf.org. ▪ Federal Reserve System (http://www.federalreserve.gov): provides detailed statistics on economic conditions. ▪ St. Louis Federal Reserve District (http://www.stlouisfed.org): provides updated information about U.S. economic conditions. ▪ Survey of Current Business is also online at http://www.bea.gov. ▪ Yahoo! Finance: provides information and news about economic conditions. Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (9 of 11) Industry conditions – Stock prices susceptible to industry conditions ▪ Industry indicators Integrating your analyses – Analyzing the firm, the economy and the industry allows assessment of future performance Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (10 of 11) Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  Analyzing Stocks (11 of 11) Limitations of stock analysis – Difficulty in forecasting future conditions – Favorable attributes are reflected in the stock price Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-31 Numerical Measures that Influence Investment Decisions Corporate earnings – One of the most significant factors in changes in the value of a stock – Source of dividend payments – Often a reflection of the health of the firm Earnings per share (EPS) – Corporation’s earnings divided by the number of outstanding shares of common stock – EPS Increase = generally a healthy sign Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-32 Numerical Measures that Influence Investment Decisions, continued Price-earnings ratio (PE) – Price per share of stock divided by the firm’s earnings per share – How much an investor is paying for a company’s earning power – P/E > 20  investor optimism – P/E < 20  lower earnings expectations – Compare to firms in same industry Projected Earnings – EPS and PE based on historical data – Future expectations more relevant Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-33 Dividend Yield and Total Return Dividend yield – Annual dollar dividend divided by current price per share – Dividend yield increase = healthy sign – Total Return ▪ Dividends plus capital gains ▪ Cash income + Price appreciation Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-34 Other Factors that Influence the Price of a Stock Beta – Volatility of a stock relative to the market – Market has beta = 1.0, higher beta for stock means greater volatility (risk) Book value per share – (Assets - Liabilities) divided by Number of shares – Market price per share is often > book value The price an investor is willing to pay is determined by: – Expected future dividends – Potential increase in price – Price uses time value to find present value of first 2 Stock market bubble – Stocks are trading above their actual worth – Driven by investor optimism and irrational expectations – Bubbles “burst” Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-35 Buying and Selling Stocks A primary market is a market in which an investor purchases financial securities, via an investment bank or other representative, from the issuer of those securities. – Investment bank is a financial firm that assists corporations in raising funds, usually by helping sell new security issues (underwriting). IPO – When a corporation sells stock to the general public for the first time Secondary Market – A market for existing financial securities that are currently traded among investors Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved  12-36 Secondary Markets for Stocks Securities exchange – Marketplace where members, representing investors, meet to buy and sell securities – Securities sold on an exchange must be listed, or accepted for trading, on that exchange. “A Listed Market” = NYSE Designated “Specialists” – Buy or sell a particular stock – Responsible for maintaining a fair and orderly market Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved