Dhanashri Academy
Common Stock Investments
Key Topics Key topics include: long-term perspective; advantages and disadvantages; characteristics, new issues, stock quotations and transaction costs; measures of common stock value; dividends; different kinds of common stock; and uses and strategies of common stock investing.
Common Stock ď‚— Represents ownership in a corporation and allows investors
to participate in the profits ď‚— Stocks offer investors the opportunity to shape an investment program to their individual needs
Stock Returns ď‚— Stock returns come mainly from capital appreciation ď‚— Stock market returns have averaged about 12% per year over
the past 50 years, but over 18% during the past decade
Advantages: Common Stock Potential for high returns; no upper limits. May provide current income return from dividends. Shares are highly liquid and easily transferred. Transaction costs are relatively low; on-line trades can
be very cheap. Low unit prices relative to other securities.
Disadvantages: Common Stock Earnings and performance are subject to wide swings. Selection of common stocks is complex. Current income is relatively low, compared to bonds.
Publicly Traded Stocks Public offering an offering to sell to the investing public a set number of shares
of a firm's stock at a specified price
Rights offering an offering of a new issue of stock to existing shareholders, who
may purchase new shares in proportion to their current ownership position
Publicly Traded Stocks Stock spin-off a conversion of one of a firm's subsidiaries to a stand-alone
company by distribution of stock in that new company to existing shareholders
Stock splits a maneuver in which a company increases the number of shares
outstanding by exchanging a specified number of new shares of stock for each outstanding share
Publicly Traded Stocks Treasury stock stock that has been sold and subsequently repurchased by the
issuing firm Classified common stock Stock issued by a company in different classes, each of which
offers different privileges and benefits to its holders
Buying and Selling Stocks ď‚— The investor must be familiar with stock quotes ď‚— The investor must also consider transaction costs
Stock Quotes NYSE – New York Stock Exchange AMEX – American Stock Exchange NASDAQ Published in a twelve-column format
Column Titles 52 weeks Hi highest price within past year, adjusted for stock splits if any
52 weeks Lo lowest price w/n past year
Stock name of company
Column Titles (2 of 5) Sym ticker symbol; 1-3 characters on NYSE and AMEX; 4-5 on
NASDAQ. Div annual dividend
Column Titles Yld % dividend yield based on current annual dividend divided by
market price PE - price-earnings ratio based on most recent four quarters of earnings Vol 100s number of shares traded yesterday (in 100s)
Column Titles Hi highest price at which stock traded yesterday
Lo lowest price yesterday Close - closing price yesterday
Column Titles Close closing price yesterday
Net Chg change in price from close of previous day
Transaction Costs ď‚— average 1-5% of value of transaction when using a full-
service broker ď‚— Odd-lot trades (less than 100 shares) carry an added cost
called odd-lot differential
Transaction Costs (continued) ď‚— Discount brokers can save an investor up to 70% on
commission ď‚— On-line trades can now cost less than $ 10 per trade
Measures of Value Par value the stated or face value (meaningless for investment purposes)
Book value the amount of shareholder equity in a company; equals the
amount of the firm's assets minus liabilities and preferred stock
Measures of Value
(continued)
Market value the prevailing price of a security.
Investment value the amount that investors believe a security should be trading
for, or what they think it's worth.
Dividends and Earnings per Share (EPS) ď‚— The directors make the dividend decisions based on several
factors. ď‚— Earnings per share (EPS) represents the amount that is earned per share EPS = (net profit after taxes - pfd dividends) # shares outstanding
Dividends and Earnings per Share (EPS) ď‚— Dividends are paid out of earnings, but do not have to be
paid even when the firm is profitable ď‚— Generally, however, higher EPS lead to higher dividends
Dividends (Important dates) Record date date on which an investor must be a registered shareholder to be entitled to receive a dividend Ex-dividend date 3 business days prior to the date of record; determines if one is an official shareholder and thus eligible to receive a declared dividend Payment date the actual date on which the company pays the dividend
Cash Dividends and the Dividend Yield ď‚— Dividends are normally paid in cash, although stock
dividends are also common. ď‚— Cash dividends are current income, which can be
expressed as the dividend yield. ď‚— Dividend yield = annual dividend per share
market price per share
Dividend Payout Ratio (DPR) One measure of stability of the cash dividend is the dividend
payout ratio (DPR). DPR = dividend per share / current market price per share. A high DPR could suggest difficulty in paying future dividends.
Dividend Reinvestment Plans and Stock Dividends Dividend reinvestment plans (DRIPs) plans in which shareholders have cash dividends automatically
reinvested into additional shares. Stock dividend A dividend payment in the form of additional shares of stock.
Market Classifications of Common Stock Blue chip stocks financially strong, high quality stocks with long and stable records of earnings and dividends. Income stocks Have long and sustained records of paying higher-than-average
dividends. Growth stocks experience high rates of growth in operations and earnings.
Market Classifications of Common Stock Speculative stocks offer the potential for substantial price appreciation, usually because of some special situation, such as new management or the introduction of a promising new product. Cyclical stocks Stocks whose earnings and overall market performance are
closely linked to the general state of the economy.
Market Classifications of Common Stock Defensive stocks tend to hold their own, and even do well, when the economy starts to falter. Mid-cap stocks medium-sized stocks, generally with market value of less than $3-4 billion, but more than $750 million. Small-cap stocks have market value of less than $750 million, and may offer above-average returns.
Foreign Stocks Foreign equity markets outperform US markets in most years
Investors can buy foreign stocks directly Has many logistical problems
American Depository Receipts (ADRs) Backed by foreign securities held by US banks
Foreign Stocks Both direct purchase and ADRs have usual risks associated with common stocks, plus the
currency exchange rate risk that drastically can affect total return. Total return in US$ = dividends + cap gains (losses) + (or) -
changes in FOREX rates.
Investment Strategies Investment strategies can be employed to satisfy one of three
basic investment needs: warehouse of value accumulation of capital and/or as a source of income
Buy-and-Hold Strategy and The HighIncome Approach The most basic strategy is the buy-and-hold. High-quality stocks are selected and held for extended periods; a strategy popular with value-oriented investors. The high-income approach uses common stocks for current income. Since dividends
mostly increase through time, the level of current income increases as well.
Quality Long-Term Growth and Aggressive Stock Management Quality long-term growth a less conservative strategy. This strategy relies on capital gains
as the primary source of return.
Aggressive stock management uses quality issues to seek attractive rates of return in a fully
managed portfolio. has substantial risk and requires a substantial amount of investor time.
Speculation and Short-Term Trading Speculation and short-term trading the highest risk strategy. investor seeks returns from capital gains while holding the stock
only a short period of time.
Using Investment Strategies The first three strategies go well with the objective to use
stocks as a warehouse of value All five could be used to accumulate capital The high-income strategy fits best with the objective of using stocks as a source of income
Popular Investment Strategies Some Popular Investment Strategies Include: Growth Investing, which is investing in stocks with above average forecasts
of earnings growth and high price/earnings ratios in expectation of higher returns. Value Investing, which is investing in stock of companies that are out of favor with the market for some reason, as reflected by low price/earnings ratios and low prices compared to their fundamentals. Sector Investing, which is an investing style based on the premise that certain industry sectors perform better during specific stages of the economic cycle. Momentum Investing, which is an investing style that focuses on using relative stock price movement to determine when to buy and sell.