Module 5
Stocks
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Module 5 Learning Objectives
• Define what a stock is and explain why companies issue stock.
• Explain how an investor makes a return on stocks.
• Categorize stocks as small, medium or large cap; as growth or income; and by industry.
• Define the common stocks, preferred stocks, tracking stocks, spin-offs, stock splits, and
IPO.
• Explain how stocks are traded.
• Find and interpret a stock quote using a financial website.
• Differentiate market, limit, and stop loss orders.
• Explain the role of the Securities and Exchange Commission in financial markets.
• Explain how a stock exchange works.
• Differentiate between the New York, American and NASDAQ exchanges.
• List stock ownership rights.
• Differentiate between institutional, insiders and individual investors.
• Use a stock index to measure stock performance.
• Differentiate between the Dow Jones Industrial Average, the Standard and Poor’s 500, the
Russell 2000, the Wilshire 5000, the Standard and Poor’s 400, and the NASDAQ
Composite.
• Create and track a stock portfolio.
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When you buy stock in a company, you are mainly investing in:
• What the company has done.
• Real estate.
• Future cash or earnings.
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What Is Stock?
4

Companies issue stock to:
• Make a killing.
• Pay for buildings, systems, or other things that will help grow the earnings of the company.
• So they don’t have to borrow.
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Why Companies Issue Stock
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How Do You Make Money With Stocks?
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Calculate Capital Gain and Dividend Yield
• You bought General Motors at $50 per share in 1998 and sold it at $74 in 2000. For each share, you received $2 in dividends in 1998 and 1999.
• You bought Ford at $25 per share in 1998 and sold it at
$29 in 2000. For each share, you received $1.07 in 1998 and $1.17 in1999 in dividends.
• You bought Daimler-Chrysler at $70 per share in 1998 and sold it at $54 in 2000. For each share, you received
$2.13 in 1998 and $2.13 in 1999 in dividends.
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How Stocks Have Performed
Annual Total Returns 1971-2000
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
Source: Global Financial Data www.globalfindata.com
T-Bill Total Return
Government Bonds Total Return
Stocks Total Return
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Here’s another way of looking at how stocks performed
Average for 1970-
2000
Maximum
Minimum
Standard
Deviation
Cash
(90 day T-Bill)
6.7%
15.2%
3.1%
2.7%
Annual Return
Bonds
(Treasury
Bond)
9.9%
44%
-7.3%
9.3%
Stocks
(S&P 500)
14.5%
37.7%
-27%
16.5%
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Choices
• Industry
• Size (Market Cap)
• Growth or Income (Capital Gain or
Dividend)
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Small caps are better performers over the long run
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Classify this stock by market cap, industry, and price earnings.
• Tootsie Roll sells—tootsie rolls and all kinds of candy.
The company has 49.5 M shares outstanding and is currently selling at $46. Earnings per share for the year was $1.53, and the company gives dividends of 28¢ per share.
• Market cap is calculated by taking shares outstanding and multiplying by price.
• Price earnings is price divided by earnings per share. It tells you what you’re paying for every dollar of earnings.
• Growth stocks have higher PEs than the market. Value stocks have lower PEs than the market.
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True or False?
If you own common shares in a company you--
• Choose the colors for the company logo
• Vote for the board of directors
• Are not allowed to look at the financial statements for the company. These are private and not disclosed to anyone outside.
• Are entitled to any extra cash the company has.
• Can sell your stock anytime you want.
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Preferred Stock
• About 500 listed on the NYSE and 200 listed on the AMEX and NASDAQ
• Preferred shareholders have rights to assets over common shareholders
• Usually no voting rights
• Dividend based on fixed rate when issued
• Moves very much like a bond
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80
60
40
20
140
120
100
IBM Common versus IBM Preferred
IBM Common
$120 per share
$0.62 dividend
0.5% yield
IBM Preferred
$25 per share
$1.88 dividend
7.5% yield
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Stock Splits
• Average stock price $30 to $45
• When a stock price gets too high, some companies believe that small investors won’t buy
• Splitting the stock does nothing to the fundamentals of the company
• But does tend to give a psychological lift to the stock price
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IPOs
Number of IPOs
600
500
400
300
200
100
0
900
800
700
AMEX
NYSE
NASDAQ
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
• More IPOs in up markets.
• Overall do good the first year and then it’s anyone’s guess.
• Only about 20% of the company is offered the first time around.
• Many risks.
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Where are they now?
Best performing IPOs in 1999.
• Internet Capital Group ICGE
• Commerce One CMRC
• VerticalNet VERT
• Brocade Communications BRCD
• PurchasePro PPRO
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How Do You Buy Stocks?
• You need to understand what you’re doing
• Check the following before you sign on the dotted line:
– Are you protected if the firm goes under?
– Have there been any complaints filed against the firm?
– What about margin accounts?
– Have you read the account agreement carefully?
• What is binding arbitration?
• What is discretionary authority?
• Check out online brokerage agreements.
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The Auction Process
• Stock trades are executed through an auction process.
• Stocks are worth whatever someone will pay for them.
• Bid : What the buyer wants to pay.
• Ask : What the seller want to sell for.
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Finding the stock quote
• Using finance.yahoo.com, find the stock quote for Coca Cola
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Placing the Order
• How many shares? (Remember prices fluctuate)
• Right ticker symbol (Especially if you’re trading online)
• Type of Order (Market, limit, stop limit, stop loss)
• How long is the order good for? (Immediate or cancel, Good Til Canceled)
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What type of order?
• Case 1: You have decided to buy a stock that is very volatile. Daily prices can go up and down $5. The current price is $50. You only have $5000 to invest in this stock. What kind of order should you place?
• Case 2: The market took a big fall yesterday, and all indications are that it will fall again today. You want to sell your stock if it hits $40 and prevent any further losses. It started out yesterday at $55 and is hovering around $48 today. What do you do?
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Securities and Exchange Commission (SEC)
• Ensures financials are “real” or disclosure
• That people who know more don’t benefit at the expense of small investors
• That brokers and firms don’t engage in shenanigans
• Funds behave properly as well
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Stock Exchanges
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New York Stock Exchange (NYSE)
New York Stock Exchange
2003
Number of shares traded a year 204 B
Market value of companies
Average price per share
Number of companies
$14 T
$27.50
2759
2000
262.5 B
$12.4 T
$37.61
2862
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National Association of Securities Dealers Automated
Quote System NASDAQ
NASDAQ
Number of shares traded per year
Market value of companies
2006
273 B
$5.2 T
Average price per share
Number of listed companies 3200
2000
443 B
$3.6 T
$31.64
4734
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American Stock Exchange (AMEX)
American Stock Exchange
2006
Number of shares traded 20 B
Market value of companies $570 B
Average price per share
Number of listed companies 1433
2000
13 B
$125 B
$55.85
765
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Types of Shares and Dilution
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Types of Investors
Who Owns Stock
Funds
19.1%
Brokers and Dealers
0.4%
Households
38.3%
Public Pension Funds
11.3%
Private Pension Funds
11.6%
Insurance Companies
6.5%
Banks
2.0%
Foreign Investors
10.0%
Government
0.7%
Source: Federal Reserve Flow of Funds
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Evaluating Stocks
• Over the long term (over 10 years) stocks perform the best
• Passive strategy
– Buy index funds and hold (you still need to watch your investments)
• Active strategy - Select stocks
– Fundamental analysis
– Technical analysis
– Speculation
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Monitoring Your Stocks
• Whether you use an active or passive strategy, you still need to monitor your stocks
• Measure stock performance against stock index
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20%
10%
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10%
Dow Jones Industrial Average (DJIA)
Annual Return
Large Cap Index - Dow Jones Industrial Average
40%
S&P 500
DJIA
30%
Oldest and most wellknown stock index.
Covers 30 very large companies.
Price-weighted index so the stock with the highest price (IBM) has the most influence.
-20%
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Annual Return
100%
80%
60%
S&P 500
Russell 2000
NASDAQ Composite
S&P 400
DJIA
Wilshire 5000
40%
20%
-40%
-60%
Standard and Poor’s 500 - Large Cap
Large Cap Index - S&P 500
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-20%
500 largest stocks
Market valueweighted index.
GE, Exxon Mobil,
Microsoft,
Citigroup, and
Pfizer are the largest companies
Used as an index for large companies
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Russell 2000 - Small Cap
Also S&P 600
Small Cap Index - Russell 2000
Annual Return
50%
40%
S&P 500
Russell 2000
30%
20%
10%
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10%
-20%
-30%
Take the top 3000 companies and select the bottom
2000
Russell 2000 is the index for small cap companies
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Wilshire 5000 - Total Market
Total Market Index - Wilshire 5000
Annual Return
40%
30%
S&P 500
Wilshire 5000
20%
10%
0%
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10%
-20%
All U.S. (7000) companies listed on the exchanges
True index for total stock market
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Standard and Poor’s 400 - Mid Cap
Mid Cap Index - S&P 400
Annual Return
40%
30%
S&P 500
S&P 400
20%
10%
0%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10%
-20%
Next 400 stocks after the S&P 500
Measure of medium cap stocks
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Other Indices
Annual Returns of Selected Asset Classes
20%
10%
0%
-10%
-20%
-30%
50%
40%
30%
2002 2003 2004
Philadelphia
GoldSilver
S&P Midcap
Russell 2000 Small
Cap
S&P 500
EAFE International
Developed
NAREIT Real
Estate
2005 2006
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Summary
• For US large cap stocks – S&P 500
• For US mid cap stocks – S&P 400
• For US small cap stocks – S&P 600
• International – MSCI EAFE
• Emerging – MSCI Emerging
• Bond – Lehman Brothers Aggregate
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Measure Your Performance
• Measure your portfolio against the appropriate index
• If your portfolio is not performing well, might consider index
• Don’t make snap judgments - even the best advisors have bad years
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