Investing in Stock
Chapter 12
Personal Finance
12.1 Characteristics of Stocks
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Common Stock – A type of stock
that pays a variable dividend and
gives the holder voting rights.
Preferred Stock – A type of stock
that pays a fixed dividend and
carries no voting rights.
12.1 Classifying Stock Investments
Income versus Growth Stocks
 Income stocks have a consistent
history of paying high dividends.
 Growth stocks are incorporations
that reinvest their profits into the
business so that it can grow.
12.1 Classifying Stock Investments
Less-Established versus Blue Chip
Stocks
 Less-Established have higher overall
risk that stocks of companies that
have been successful for many
years.
 Blue Chip Stocks are stocks of
large, well-established corporations
with a solid record of profitability.
12.1 Classifying Stock Investments
Defensive versus Cyclical Stocks
 A defensive stock is one that
remains stable and pays dividends
during an economic decline.
 Cyclical stocks do well when the
economy is stable or growing but
often do poorly during recessions,
when the economy slows down.
12.1 Determining a Stock’s Worth
Stock Value
 Par Value is an assigned (and often
arbitrary) dollar value. Par value is
an artificial number.
 Market value is the price for which
the stock is bought and sold in the
marketplace.
12.1 Determining a Stock’s Worth
Factors Affecting Stock Price
1. The Company – how well is the
company performing
2. Interest Rates – low rates,
encourage investing
3. The Market – does the product sell
4. Earnings per Share – how much is
the stock worth
12.1 Questions P. 285
In what two ways can you make
money from owning stock?
Stockholders profit through dividends
and through capital gains (gain in
value over time)
1)
12.1 Questions P. 285
2) How is an income stock different
from a growth stock?
Income stocks are stocks that have a
consistent history of paying high
dividends. Growth stocks are
stocks in corporations that
reinvest their profits into the
business so that it can grow.
12.1 Questions P. 285
3) Why do stockholders want to know
a corporation’s earnings per
share?
Stockholders reinvestment avoids a
broker fee as well as the tax
consequences of receiving cash
dividends on the stock.
12.2 The Securities Market
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Securities Exchange is a
marketplace where brokers who are
representing investors meet to buy
and sell securities.
Floor brokers buy and sell stocks on
the exchange.
The exchange of the auction market
where buyers and sellers are
brought together to trade securities.
12.2 The Securities Market
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Over-the-Counter Market is a network of
brokers who buy and sell the securities of
corporations that are not listed on a
securities exchange. Brokers in the OTC
market do not deal face-to-face.
Bull market is a prolonged period of rising
stock prices and a general feeling of
investor optimism.
Bull market is a prolonged period of
falling stock prices and a general feeling
of investor pessimism.
12.2 Investing Strategies
Short Term Techniques
 Buying on Margin allows you to
borrow money from your broker to
buy stock if you open a margin
account and sign a margin contract.
 Short Selling is selling stock
borrowed from a broker that must
be replaced at a later time.
12.2 Investing Strategies
Long Term Techniques
1. Buy and Hold
2. Dollar-Cost Averaging
3. Direct Investment
4. Reinvesting Dividends
12.2 Reading the Stock Listings
12.2 Reading the Stock Listings
1.
2.
3.
4.
Columns 1 and 2 – show the
highest and lowest price this stock
sold for this year
Column 3 – lists the stocks
alphabetically by name
Column 4 – shows the cash
dividend per share for the year
Column 5 – percent yield
12.2 Reading the Stock Listings
5.
6.
7.
8.
Column 6 – price/earnings ratio
Column 7 – shows sales in
hundreds of shares from the
previous day
Columns 8, 9, and 10 – highest,
lowest and closing price for this
stock on the previous day
Column 11 – net change
12.2 Stock Indexes
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A stock index is a benchmark that
investors use to judge the
performance of their investments.
The Dow Jones Industrial Average
(the Dow) is one widely followed
stock index.
The Standard & Poor’s 500 and the
NASDAQ Composite Index are other
commonly used indexes.
12.2 Questions P. 296
What are two kinds of markets
where securities are bought and
sold?
Securities are bought and sold in a
security exchange or in the overthe-counter market.
1)
12.2 Questions P. 296
2) Why is buying on margin risky?
With a margin purchase, you are
betting that the stock will increase
in value. It may or may not.
12.2 Questions P. 296
3) How do you save money by
reinvesting dividends?
Dividend reinvestment avoids a
broker fee as well as the tax
consequences of receiving cash
dividends on the stock.
Review Facts and Ideas Page 300
1) How would you earn a capital gain
on your stock?
Capital gain is an increase in the
value of the stock above the price
initially paid for it.
Review Facts and Ideas Page 300
2) How is common stock different from
preferred stock?
Common stockholders vote to elect the
board of directors and are entitled to a
vote on major corporate issues at the
annual stockholder meetings. They
share in the profits of a corporation;
however, dividends are not guaranteed.
If there are no profits, there are no
dividends.
Review Facts and Ideas Page 300
2) How is common stock different from
preferred stock?
Preferred stock has guaranteed dividends
stated either as a percentage of the par
value or a stated amount of money for
each share of stock. This dividend is
paid before any dividend payments are
made to common stockholders.
Review Facts and Ideas Page 300
3) What type of investor should purchase
income stocks? Growth stocks?
Income stocks are purchased by people
such as retirees who are seeking a
monthly income.
Growth stocks are purchased as a long-term
investment by people not desiring
regular income but seeking dollar
appreciation of stock value.
Review Facts and Ideas Page 300
4) Which involves the greatest risk – stocks
of young businesses or blue chip stocks?
Explain the differences between the two
types of stocks.
Young businesses have less-established
stock which are more risky because
they represent companies that are small
with no track record. If the companies
succeed, the potential return is very
high.
Review Facts and Ideas Page 300
4) Which involves the greatest risk –
stocks of young businesses or blue
chip stocks? Explain the
differences between the two types
of stocks.
A blue chip stock is a very safe
investment that generally attracts
conservative investors.
Review Facts and Ideas Page 300
5) Why are defensive stocks not subject to
the usual ups and downs of business
cycles?
Defensive stocks usually remain stable
during declines in the economy.
Companies in this category typically
have stable earnings and continue
dividend payments to stockholders
during periods of economic decline.
Review Facts and Ideas Page 300
6) Explain the relationship between
par value and market value.
Par value is the stated value of a
stock when it is issued. Market
value is what the stock is selling
for in the securities marketplace.
There is no relationship between
par (stated) value and market
value.
Review Facts and Ideas Page 300
7) What causes stock prices to rise and fall?
List four factors that affect stock prices.
Stock prices rise and fall based on:
1)
How the company is doing (financial
condition)
2)
Current interest rates
3)
The market for the product or service
provided by the company
4)
The earnings per share of the company
Review Facts and Ideas Page 300
8) What is the largest stock exchange in the
United States? How does a company get
listed on this exchange?
The New York Stock Exchange is the largest
in the United States. Before a company
is listed on the exchange, certain
criteria must be met. A total of at least
1.1 million shares of its common stock
must be publicly owned with a market
value of at least $9 million.
Review Facts and Ideas Page 300
9) Why would a stock be listed on the
NASDAQ rather than the NYSE or
American Stock Exchange?
A stock would be traded on the NASDAQ
(over-the-counter) if the stock issued
was under the dollar amount and
publicly held shares requirements for
stock listed on the New York or
American exchanges.
Review Facts and Ideas Page 300
10) What characterizes a bull market?
A bear market?
A bull market develops when
investors are optimistic about the
overall economy and purchase
stocks.
A bear market develops when
investors are pessimistic and sell
stocks.
Review Facts and Ideas Page 300
11) Explain two short-term strategies
for investing in the market.
Buying stock on margin – an investor
borrows part of the money
necessary to buy a particular
stock.
Short selling – selling stock that has
been borrowed from a broker and
must be replaced at a later date.
Review Facts and Ideas Page 300
12) Explain four techniques for long-term
investing.
1)
Holding stocks for a long time (buy and
hold)
2)
Dollar-cost averaging (lowering the
average price of stock purchases)
3)
Direct investment (buying stock directly
from the corporation)
4)
Dividend reinvestment (buying
additional shares with cash dividends.
Review Facts and Ideas Page 300
13) Why do investors use dollar cost
averaging?
Dollar cost averaging allows steady
investing without regard to current
market price and over the long run,
usually nets the lowest possible average
purchase price. This way, the investor
does not have to try to guess when
stocks are at their lowest to time the
purchase.
Review Facts and Ideas Page 300
14) In stock listings, what do these
symbols stand for P/E, s, pf?
P/E means price-earnings ratio
‘S’ indicates a stock split
‘pf’ stands for preferred stock
Review Facts and Ideas Page 300
15) How do investors use stock
indexes?
A stock index is a benchmark that
investors use to judge the
performance of their investments.
The most widely followed stock
index is the Dow Jones Industrial
Average.