Lecture 03

Economics 98/198 Decal
Spring 2008
Today’s Schedule
 Administrative Issues
 Current Events
 Last Week’s Lecture
 Lecture Content
 Basics of Investing
 Market capitalization
 Earning reports
 Stocks splits / stock buybacks
 Investing on Margin
 Short-selling
 Industries / Sectors
 Assigned Reading / Next Week
Administrative Issues
 Enrollment
 Make sure you’re registered on Tele-Bears
 Investopedia Simulation Competition
 Submit your $5 into the class envelope
 Make sure you write username on sign-up sheet
 Start trading!
 Investor’s Business Daily online subscription
 Next week’s class: 20 Barrows
Lecture Content
Last Week
 Stock Basics
 What is stock? What are its main characteristics?
 Dividends
 Market Exchanges
 How are stocks traded?
 Primary vs. Secondary Markets
 Indices (Index)
 What is an index? What are the main ones?
 Brokerage
 Full service vs. discount
 Commissions
 Different types of orders
 Market / Limit / Stops / Stop-limit
Different Types of Orders, revisited
Different types of Orders
 Limit Order
 An order to buy or sell a set number of shares at specified price of
better. Limit orders usually cost more, but useful for getting
specified price.
 Stop Order
 An order placed for a security for when the price surpasses a
particular point, which helps buy or sell at a particular price.
Limiting loss or locking profits. Many people use this during
 Stop Limit Order
 Executed at a specified price (or better) after a given stop price has
been reached. Order becomes then a limit order to buy (or sell) at
the limit price or better
 Precision purposes
Market Capitalization
Market Capitalization
 Also known as “market cap”
 Refers to the value of ALL company outstanding
shares (shares owned by investors)
 Useful for gauging a company’s size and therefore,
some of the risk characteristics associated
Market Cap =
Stock Price
# of shares outstanding
(stock held by investors, management, & insiders)
Market Capitalization
 Example. Amazing DeCal Cookies Co., Ltd.
 Share Price $20
 Shares Outstanding: 50,000,000 shares
 Market cap?
 Example. Berkeley Traders Co., Ltd.
 Share Price $100
 Shares Outstanding: 1,000,000 shares
 Market Cap?
Different Capitalizations
 Not exact, but general guidelines for size categories
 Large Cap
 Companies with $10b - $200b market cap
 Often referred to as “blue-chip” stocks (low volatility, dividends)
 “Mega-Cap” - $200b+ (HUGE)
 Mid Cap
 Companies with $2b - $10b market cap
 Small Cap
Companies with $300m - $2b market cap
Typically newer, relatively younger companies
Can present potential for greater capital gains, but at greater risk
“Micro-cap” - $50m-$300m market cap – VERY SMALL
Market Capitalization Perspective
Large Cap
 Microsoft (Nasdaq: MSFT) $264 billion
 Wal-Mart (NYSE: WMT) $201 billion
 Coca-Cola (NYSE: KO) $138 billion
 Walt Disney (NYSE: DIS) $60 billion
 Yahoo! (Nasdaq: YHOO) $40 billion
Small/Mid - Cap
 Logitech International (Nasdaq: LOGI) $5 billion
 Chipotle (NYSE: CMG) $3.6 billion
 Crocs Inc. (Nadaq: CROX) $2.76 billion
 J Crew Group Inc. (NYSE: JCG) $2.62 billion
 Barnes & Noble (NYSE: BKS) $1.88 billion
 Papa Johns (Nasdaq: PZZA) $694 million
Source: Google Finance
Comparing Small and Large Caps
(S&P 500 vs. S&P 600) – last decade
Black line = S&P 500
Source: Stockcharts.com
Orange line = S&P 600
Comparing Small and Large Caps
(Dow Jones vs. S&P 600) - recent
Blue line = Dow Jones
Source: Stockcharts.com
Red line = S&P 600
Comparing Large/Mid/Small Cap
Source: Stockcharts.com
Stock Splits
Stock Buybacks
Stock Splits
 When a company divides the number of its
existing stocks into multiple shares
 In 2-for-1 split, each stockholder gets an
additional share for each share held
 Also, value of each share is reduced in half:
2 shares now equal original value of 1 share
before split (total value not changed)
Stock Splits
Alternatively, think of it this way…
 If you have a $100 bill, and I exchange with you two
$50 bills
 How many bills do you have?
 What is the total value of money you have?
Stock Splits
 Why do companies do this?
 Brings the share price down to a more “attractive”
level for smaller investors (purely psychological)
 Can potentially result in price increase because these small
investors will be more likely to buy the stock
 Some also say stock split will increase price because it is a
signal of strong growth
 Increases stock’s liquidity (this increases when ↑ in #
of outstanding shares)
Stock Splits
 Effects
 Excessive stock splits may hurt a stock’s price
 Pros and shrewd traders sometimes use excitement
generated by oversized or excessive split as an opportunity
to sell and take their profits
 Oversized splits create substantially larger supply
Stock Buybacks
 When a company buys back its own shares in the
market place
 Also known as “share repurchase”
 Why do it?
 Management believes its stock is undervalued (its too
 Management has confidence in the company and
want to send a message the market
Stock Buybacks
 # of shares outstanding go down as these shares are
bought by the company
 Major impact is that it affects important financial
ratios (ROA, ROE, P/E, EPS)
 What do these ratios mean?
 Briefly, we use them to value or analyze a company
 We’ll discuss this more later
 Are they good or bad?
 Not definitive answer, depends on the situation
Investing on Margin / Short Selling
Investing on Margin
 Borrowing money from brokerages to invest
 Generally, maximum 50% of a purchase can be on
 However, when borrowing money, have to pay
interest on money borrowed
 Ex. I borrow $10,000 and broker charges 5% rate. I have to
pay $500 (10,00 x 0.05) to borrow that money.
Investing on Margin
 Potential to get greater profits than investing
with only cash because you profit from money
you don’t have
 Works against you when you lose money – can
get really ugly with losses
 Charged interest
 Marginal calls
Margin Example
Joe buys 100 shares priced at $50 of Smart Inc.
(SMRT) and is allowed to buy another 100 shares
on margin at 10% interest.
100 shares @ $50 (cash)
100 shares @ $50 (margin)
--------------------------------------------------Total Investment
(200 shares @ $50)
Margin Example continued
SMRT goes through the roof and increases 100% in 10
months to $100. Joe smartly sells and takes profits.
SMRT Investment (200sh@$100)
Money borrowed from brokerage
Interest on borrowed money
Original Investment
% Return ($9,500/$5,000)
vs. % Return (cash investment only)
Shorting Stocks
 Betting a stock will go down and attempting to
profit from that downward movement
You essentially “borrow” shares from another
investor (account must be able to trade on margin)
2. You sell those shares at the market price
3. You then wait and root for the stock price to tumble
4. Then you cash out, whether at a profit of loss
5. You then buy the shares at the new market price
and return the shares to their owner
Shorting Example
Scenario 1
Mr. Giant shorts 1000 shares of Lampere Co. at $20 a
share – his account gets credited with $20,000
Lampere Co. stock plummets to $10 a share
Borrowed and sold short 1000 shares at $20
Bought back and returned 1000 shares at $10
% Gain
Shorting Example
Scenario 2
Mr. Giant shorts 1000 shares of Lampere Co. at $20 a
share – his account gets credited with $20,000
Lampere Co. stock skyrockets to $60 a share
Borrowed and sold short 1000 shares at $20
Bought back and returned 1000 shares at $60
% Loss
Going Short
 Can profit during market downturns
 More difficult than buying stocks
 Betting against history
 Must constantly monitor positions
Sector / Industries
Cyclical vs. Non-Cyclical
Sector vs. Industry
 Often used interchangeably, but actually mean slightly
different things
 Sectors are the general segments in the economy within
which large groups of companies can be categorized into
 About a dozen sectors in the economy
 Example. Financial Sector, Technology, Basic Materials
 Industry describes a much more specific grouping of
companies with highly similar business activities
 Break down sectors into much more defined groups
 Can be small, but also very large in numbers
 Example. Financial Sector  Asset Management, Insurance,
Commercial Banks, Investment Banks, etc.
Sector vs. Industries
 Top sectors / industries rotate every cycle
 Important to know which sectors / industries are leading
the market and performing well
 Why? Let’s think back to 1998
 Technology, software, telecom: leading industries then
 If you invested in those industries , the price would have
likely made a solid, if not major, price increase
 Stock prices of companies in the same / similar
industry usually (not always) move in a similar fashion
Recent Industry Performance
Recent Sector Performance
Cyclical Stocks / Industries
 The term refers to how correlated a company’s
price (or industry) is relative to economic
 Non-cyclical stocks (also called defensive stocks)
refer to companies not as susceptible to economic
 Example. Household non-durables, tobacco, utilities,
 These are often goods that necessities rather than
Cyclical vs. Non-Cyclical Stocks
 Ford = Blue
Red – Florida Public Utilities
 Market Capitalization
 Small caps vs. large caps
 Stock Splits
 Stock Buybacks
 Shorting Stocks
 Margin
 Industries vs. Sectors
 Cyclical Stocks / Industries
For Next Week
 Quiz on Stock Market Basics
 Introduction to Other Investment Securities
 Bonds / Mutual Funds / Exchange-Traded Funds
 Market Psychology
 Emotions involved with stock investing
 Basic Investing Concept
 Compounding
 Investing versus Speculating
 Investment Style – Risk/Reward, Active/Passive
 Managing your Portfolio
Reading / Homework
 Beginner’s Guide to Financial Statements (SEC)
 http://www.sec.gov/investor/pubs/begfinstmtguide.h
 Are Buyback Stocks Still Good for Investors?
 Margin Trading
Online News Sources
 Reuters Business
 www.reuters.com
 Yahoo! Finance
 Finance.yahoo.com
 Investor Guide
 www.investorguide.com
 Investor’s Business Daily
 www.investors.com
 Great Site: Moneychimp
 http://www.moneychimp.com/
Brokerage Review
 Charles Schwab
 Scottrade
 Zecco
Current Events
Current Events
 Yahoo rejects Microsoft’s $45B bid
 News Corp – Integrating MySpace and Yahoo
 Not just Subprime
 The Dow makes changes
 Roger Clemens testifies before Congress
Next Week
 Remember: Next week’s class is in 20 Barrows