BUA325 Investment Analysis CH06
I.
The Appeal of Common Stocks
A.
Residual Owners: stockholders of a firm are the owners, who are entitled to
dividend income and a prorated share of the firm’s earnings only after all the firm’s other
obligations have been met
1.
Stocks allow investors to tailor investments to meet individual needs and
preferences
2.
Stocks may provide a steady stream of current income through dividends
3.
Stocks may increase in value over time through
capital gains
II.
Sometimes You Win, Sometimes You Lose: Five years of the S&P 500 Index and the
Nasdaq Composite
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
III.
Stock Prices to Stock Returns
A.
Stock Returns: take into account both price changes and dividend income
1.
Returns from capital gains range from an average of 15.3% during the
1990s to -5.3% from 2000–2008
2.
Returns from dividends vary too, but not nearly as much, ranging from
5.4% in the 1950s to 1.7% since 2000
3.
The big returns (or losses) come from capital gains
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
B.
What is a Bear Market?
1.
Routine Decline: a drop of 5% or more in one of the major market
indexes, like the Dow Jones Industrial Average (DJIA)
C.
2.
Correction: a drop of 10% or more in one of the major market indexes
3.
Bear Market: a drop of 20% or more in one of the major market indexes
Advantages of Stock Ownership
1.
Provide opportunity for higher returns than other investments
2.
Over past 100 years, stocks earned annual returns that we roughly
double the returns provided by corporate bonds
D.
3.
Good inflation hedge since returns typically exceed the rate of inflation
4.
Easy to buy and sell stocks
5.
Price and market information is easy to find in financial media
6.
Unit cost per share of stock is low enough to encourage ownership
Disadvantages of Stock Ownership
1.
Stocks are subject to many different kinds of risk:
a)
Business risk
b)
Financial risk
c)
Purchasing power risk
d)
Market risk
e)
Event risk
2.
Hard to predict which stocks will go up in value due to wide swings in
profits and general stock market performance
3.
Low current income compared to other
investment alternatives
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
E.
Figure 6.2 The Current Income of Stocks and Bonds
F.
Basic Characteristics of Common Stock
1.
Equity Capital: evidence of ownership position in a firm, in the form of
shares of common stock. This is why stocks are sometimes called “equities”
2.
Publicly Traded Issues: shares of stock that are readily available to the
general market and are bought and sold in the open market
3.
Public Offering: an offering to sell to the investing public a set number of
shares of a firm’s stock at a specified price
4.
Rights Offering: an offering of a new issue of stock to existing
stockholders, who may purchase new shares in proportion to their current
ownership
5.
Stock Spin-Off: conversion of one of a firm’s subsidiaries to a stand-alone
company by distribution of stock in the new company to existing shareholders
6.
Stock Split: when a company increases the number of shares outstanding
by exchanging a specified number of new shares of stock for each outstanding
share
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
a)
Usually done to lower the stock price to make it more attractive to
investors
b)
Stockholders end up with more shares of stock that sells for a
lower price
c)
Investor with 200 shares in a 2-for-1 stock split would have 400
shares after the stock split
d)
If the stock price was $100 before the split, the price would be
near $50 after the split
7.
Treasury Stock: shares of stock that were originally sold by the company
and have been repurchased by the company. Share repurchases are often
called “buybacks.”
a)
Reduces the number of shares outstanding to public
b)
Companies buyback when they believe stock is undervalued and
a good buy
c)
Companies may try to raise undervalued stock price or prop up
overvalued stock price
d)
May be used for mergers, acquisitions or employee stock option
plans
8.
Classified Common Stock: common stock issued in different classes,
each of which offers different privileges and benefits to its holders
a)
Different shares may have different voting rights
b)
Often used to allow a relatively small group to control the voting of
a publicly-trade company
c)
Ford family owns “B” shares and other investors own “A” shares;
Ford family controls 40% of Ford Motor Company
d)
May have different dividend payout schedules
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
G.
Figure 6.4 Stock Quotations
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BUA325 Investment Analysis CH06
H.
Watch Those Transaction Costs
1.
Round-Lot: buying 100 shares of stock or multiples of 100 shares
2.
Odd-Lot: buying less than 100 shares of stock
a)
Buying odd lots or small numbers of shares can result in higher
costs to buy and sell shares
b)
Frequent trading can increase transactions
costs substantially
I.
Common Stock Values
1.
Market Capitalization: the overall current value of the company in the
stock market
a)
Total number of shares outstanding multiplied by the market value
per share
2.
Investment Value: the amount that investors believe the stock should be
trading for, or what they think it’s worth
a)
J.
Probably the most important measure for a stockholder
Dividends
1.
Dividend income is one of the two basic sources of return to investors
2.
Dividend income is more predictable than capital gains, so preferred by
investors seeking lower risk
3.
Dividends are taxed at maximum 15% tax rate, same as capital gains
4.
Dividends tend to increase over time as companies’ earnings grow;
average annual increase around 3% to 5%
5.
Dividends represent the return of part of the profit of the company to the
owners, the stockholders
K.
Dividends and Earnings Per Share
1.
Earnings Per Share: the amount of annual earnings available to common
stockholders, stated on a per-share basis
2.
a)
Earnings are important to stock price
b)
Earnings help determine dividend payouts
Dividends and Dividend Yield
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
a)
Dividend Yield: a measure to relate dividends to share price on a
percentage basis
(1)
Indicates the rate of current income earned on the
investment dollar
(2)
Convenient method to compare income return to other
investment alternatives
3.
Dividends and Dividend Payout Ratio
a)
Dividend Payout Ratio: the portion of earnings per share (EPS)
that a firm pays out as dividends
(1)
Companies are not required to pay dividends
(2)
Some companies have high EPS, but reinvest all money
back into company
4.
Other Dividend Characteristics
a)
Stock Dividend: payment of a dividend in the form of additional
shares of stock
b)
Dividend Reinvestment Plans (DRIPs): plans where cash
dividends are automatically reinvested into additional shares of the firm’s
common stock
5.
(1)
Over 1,000 companies offer DRIPs
(2)
Usually have no brokerage fees
(3)
Uses dollar-cost averaging
Three Reasons to Love Dividends
a)
Stocks that pay dividends tend to produce higher returns than
those that do not
(1)
S&P dividend payers were up 6.5% vs. 3.6% for nondividend payers
b)
Since 1928, dividends have accounted for 40% of total return on
stocks
c)
Since 1980, dividend-payers have averaged annualized returns of
15.1% vs. 12.8% for non-payers
d)
New tax code changes: tax dividends are a much lower rate than
ordinary income and interest income
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
L.
Types of Stock
1.
Blue Chip Stocks: financially strong, high-quality stocks with long and
stable records of earnings and dividends
a)
Companies are leaders in their industries
b)
Relatively lower risk due to financial stability
of company
c)
Popular with investing public looking for steady growth potential,
perhaps dividend income
d)
Provide shelter during unsettled markets
e)
Examples: AT&T, Chevron, Johnson & Johnson, McDonald’s,
Pfizer
f)
Figure 6.5 A Blue-Chip Stock
2.
Income Stocks: stocks with long and sustained records of paying higherthan average dividends
a)
Good for investors looking for relatively safe and high level of
current income
b)
Dividends tend to increase over time (unlike interest payments on
bonds)
c)
Some companies pay high dividends because they offer limited
growth potential
d)
More subject to interest rate risk
e)
Examples: Duke Energy, Conagra Foods, Sara Lee, Altria Group
3.
Growth Stocks: stocks that experience high rates of growth in operations
and earnings
a)
Have sustained rate of growth in earnings above
market
general
b)
Investors expect higher price appreciation due to increasing
earnings
c)
Riskier investment because price may fall if earnings growth
cannot be maintained
d)
May include blue chip stocks as well as
speculative stocks
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
e)
Typically pay little or no dividends
f)
Examples: Netflix, eBay, Research in Motion, Berkshire
Hathaway, Starbucks
4.
Tech Stocks: stocks representing the technology sector of the market
a)
Range from speculative stocks of small companies that have
never shown a profit to blue chip stocks of large companies that are
growth-oriented
b)
Potential for attractive returns
c)
Considerable risk and volatility
d)
Difficult to put value on due to erratic or no earnings
e)
Examples: Microsoft, Cisco Systems, Yahoo!, NVIDIA, SanDisk,
Electronic Arts
f)
Figure 6.6 A Tech Stock
5.
Speculative Stocks: stocks that offer potential for substantial price
appreciation, usually due to some special situation such as a new product
a)
Companies lack sustained track record of business and financial
success
b)
Earnings may be uncertain or highly unstable
c)
Potential for substantial price appreciation
d)
Stock price subject to wide swings up and down in value
e)
Examples: Sirius XM Radio, Dreamworks Animation, Liberty
Media, NitroMed, Under Armour
6.
Cyclical Stocks: stocks whose earnings and overall market performance
are closely linked to the general state of the economy
a)
Stock price tends to move up and down with the business cycle
b)
Tend to do well when economy is growing, especially in early
stages of economic recovery
c)
Tend to do poorly in slowing economy
d)
Best for investors willing to move in and out of market as economy
changes
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
e)
Examples: Alcoa, Caterpillar, Genuine Parts, Lennar, Brunswick,
Timken
7.
Defensive Stocks: stocks that tend to hold their value, and even do well,
when the economy starts to falter
a)
Stock price remains stable or increases when general economy is
slowing
b)
Products are staples that people use in good times and bad times,
such as electricity, beverages, foods and drugs
c)
Gold stocks are a form of defensive stock
d)
Best for aggressive investors looking for “parking place” during
slow economy
e)
Examples: Walmart, Checkpoint Systems, WD-40
8.
Large-Cap Stocks: large companies with market capitalizations over $10
billion
a)
Number of companies is smaller, but account for 80% to 90% of
the total market value of all U.S. equities
b)
Bigger is not necessarily better
c)
Tend to lag behind small-cap and mid-cap stocks, but typically
have less volatility
d)
Examples: Walmart, Home Depot, Comcast, Microsoft
9.
Mid-Cap Stocks: medium-sized companies with market capitalizations
between $2 billion and $10 billion
a)
Provide opportunity for greater capital appreciation than LargeCap stocks, but less price volatility than Small-Cap stocks
b)
Usually have long-term track records for profits and stock
valuation
c)
“Baby Blues” offer same characteristics of Blue Chip stocks
except size
d)
Examples: Abercrombie & Fitch, Dollar Tree, Hasbro, Nordstrom,
Whole Foods
10.
Small-Cap Stocks: small companies with market capitalizations less than
$2 billion
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
a)
Provide opportunity for above-average returns
(or losses)
b)
Usually do not have a financial track record
c)
Earnings tend to grow in spurts and can have dramatic impact on
stock price
d)
Usually not widely-traded; liquidity is an issue
e)
“Initial Public Offerings” (IPOs)
f)
Examples: Callaway Golf, California Pizza Kitchen, Winn-Dixie
Stores, Shoe Carnival
M.
Investing in Foreign Stocks
1.
Globalization of financial markets is growing
a)
U.S. equity market represents roughly 35% of world
equity markets
b)
Six countries make up 80% of world equity market
c)
U.S. market remains largest equity market in world with a total
value of about $12 trillion
d)
Some of the returns in non-U.S. markets are due to currency
exchange rates, and not just markets themselves
2.
Going Global
a)
Buying Shares Directly in Foreign Markets
(1)
Most adventuresome approach
(2)
Logistical problems: fluctuating currency rates, different
regulatory and accounting standards, tax problems, “red tape”
b)
Buying American Depositary Shares (ADSs)
(1)
Simpler approach
(2)
Bought and sold on U.S. markets just like stocks in
U.S. companies
(3)
c)
Transactions are in U.S. dollars
Buying International Mutual Funds
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
3.
International investing is more complex and riskier than domestic
investing
4.
5.
N.
a)
Must pick right stock
b)
Must pick right market
c)
Must pick correct direction for currency exchange rate fluctuations
Returns on International Investments
a)
Stronger U.S. dollar has negative impact on foreign investments
b)
Weaker U.S. dollar has positive impact on
foreign investments
Alternative Investment Strategies
1.
2.
3.
O.
International investing requires investors to be right on more factors:
Storehouse of Value
a)
Safety of investment is primary goal
b)
Investors use high-quality blue chip and non-speculative stocks
To Accumulate Capital
a)
Growth of investment is primary goal
b)
Investors use growth-oriented stocks to generate capital gains
Source of Income
a)
Current income is primary goal
b)
Investors use stocks with dependable flow of dividends
Stock Investment Strategies
1.
Buy-and-Hold
a)
Investors buy high-quality stocks and hold them for extended time
periods
2.
b)
Goal may be current income and/or capital gains
c)
Investors often add to existing stocks over time
d)
Very conservative approach; value-oriented
Current Income
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
a)
Investors buy stocks that have high dividend yields
b)
Safety of principal and stability of income are
primary goals
c)
May be preferable to bonds because dividends levels tend to
increase over time
d)
Often used to provide to supplement other income, such as in
retirement
3.
Quality Long-Term Growth
a)
Investors buy high-quality growth stocks, mid-cap stocks and tech
stocks
b)
Capital gains are primary goal
c)
Higher level of risk due to emphasis on capital gains
d)
Significant trading of stocks may occur over time
e)
Diversification is used to spread risk
f)
“Total Return Approach” is version that emphasizes both capital
gains and high income
4.
Aggressive Stock Management
a)
Investors buy high-quality growth stocks, blue chip stocks, midcap stocks, tech stocks and cyclical stocks
b)
Capital gains are primary goal
c)
High level of risk due to emphasis on capital gains
d)
Investors aggressively trade in and out of stocks, often holding for
short periods
5.
e)
Timing the market is key element
f)
Time consuming to manage
Speculation and Short-Term Trading
a)
Also called “day trading”
b)
Investors buy speculative stocks, small-cap stocks and tech
stocks
c)
Capital gains are primary goal
Content Coordinator: Dr. Lawrence Byerly
BUA325 Investment Analysis CH06
d)
Highest level of risk due to emphasis on capital gains in short time
period
e)
Investors aggressively trade in and out of stocks, often holding for
extremely short periods
f)
Looking for “big score” on unknown stock
g)
Time consuming & high trading costs
Content Coordinator: Dr. Lawrence Byerly