Chapter 11
Investing in Stocks
Kapoor
 2004 McGraw-Hill Ryerson Ltd.
Dlabay
Hughes
Ahmad
Prepared by Cyndi Hornby, Fanshawe College
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Learning Objectives – Chapter 11
1. Identify the most important features of a
common stock.
2. Discuss the most important features of
preferred stock.
3. Explain how you can evaluate stock
investments.
4. Describe how stocks are bought and sold.
5. Explain the trading techniques used by longterm investors and short-term speculators.
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Learning Objective # 1
Identify the most important
features of a common stock.
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How Are The Markets Doing?
Index: a statistical measure of the
changes in a portfolio of stocks
representing a portion of the overall
market.
S&P/TSX Composite Index
Dow Jones Industrial Average
NYSE Composite Index
Nasdaq Composite Index
Standard & Poor’s 500 Stock Index
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Investing in Stocks
Why do corporations issue common
stock?
To raise money to start or expand a
business.
To help pay for ongoing business
expenses.
They don’t have to repay the money.
Dividends are not mandatory.
Stockholders have voting rights.
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Why Do Investors Purchase
Stock?
Income from dividends.
Dollar appreciation
of stock value.
Possible increased value from stock
splits (a procedure in which the shares
of common stocks owned by existing
shareholders are divided into a larger
number of shares.
 2004 McGraw-Hill Ryerson Ltd.
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Learning Objective # 2
Discuss the most important
features of preferred stocks.
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Preferred Stock
Receive cash dividends before common stock
holders are paid any cash dividends.
The dividend amount is either a stated amount of
money for each share of preferred stock, or a
percentage of the par value.
Par value is an assigned dollar value that is
printed on a stock certificate.
Callable preferred stock is stock a corporation
may exchange for a specified amount of money.
After calling an issue, they can issue new
preferred stock with a lower dividend.
First claim on corporation’s assets.
 2004 McGraw-Hill Ryerson Ltd.
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Features of Preferred Stock
Cumulative feature.
Unpaid cash dividends accumulate and must be
paid before any cash dividends are paid to the
common stock holders.
Participation feature.
Rare form of investment used to attract
investors.
Can share in earnings beyond the stated dividend
amount.
Conversion feature.
Can be traded for shares of common stock.
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Learning Objective # 3
Explain how you can evaluate
stock investments.
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Classification of Stock
Investments
Blue chip stock.
Safe investment in strong and
respected companies.
Attracts conservative investors.
ex. Bell Canada, Royal Bank
Income stock.
Pays higher than average dividends.
ex. utility stock.
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Classification of Stock
Investments
(continued)
Growth stock.
Earns above average profits of all
firms in the economy.
Less than 30% of earnings are
paid out as dividends, with rest
reinvested in research &
development
ex. Southwest Airlines, Home
Depot
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Classification of Stock
Investments
(continued)
Cyclical stock.
Follows the business cycle of advances
and declines in the economy.
ex. automobiles, timber, and steel.
Defensive stock.
Remains stable during declines in the
economy.
ex. Kellogg, Procter & Gamble and
utility stocks.
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Classification of Stock
Investments
(continued)
Large cap stocks.
Issued by a large corporation that has a large
amount of stock outstanding & a large amount of
capitalization.
Capitalization.
The total amount of securities--stocks and bonds-issued by a corporation.
Small cap stocks.
Issued by a company that has a capitalization of
$150 million or less.
Penny Stocks.
Typically sell for less than $1 per share.
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Sources of Information on
Stocks
Newspapers
The Internet
Stock Advisory Services
Charge a fee
Hundreds to choose from
Corporate News
Disclose information about corporate earnings,
assets and liabilities, products or services
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Factors that influence the price of
Stocks
Bull market.
Investors are optimistic about nation’s
economy.
More investors are buying stock
and the stock market increases.
Bear market.
Investors are pessimistic about economy.
More investors are selling stock so and the
stock market declines.
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Numeric Measures to Consider
When Evaluating a Stock
Book Value
Determined by deducting all liabilities from
the corporations assets and dividing the
remainder by the number of outstanding
shares of common stock.
May be little correlation with market value.
Book Value =
Assets – Liabilities
Outstanding Shares
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Numeric Measures to Consider
When Evaluating a Stock
Current Yield
Yearly dollar count of income generated by an
investment divided by the investment’s
current market value
Current Yield = Annual Income Amount
Outstanding Shares
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Numeric Measures to Consider
When Evaluating a Stock
Total shareholder Return (TSR)
Includes the yearly dollar amount of income
plus any increase or decreased in the original
purchase price of the investment
TSR = Current Return + Capital Gain
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Numeric Measures to Consider
When Evaluating a Stock
Annualized Holding Period Yield
Calculation that takes into account total
return, original investment and time
investment is held
Annualized Holding Period Yield = TSR
x
1
Original
N umber of
Investment
Years
Investment Held
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Numeric Measures to Consider
When Evaluating a Stock
Earnings per share
are the corporation’s after-tax earnings divided by the
number of outstanding shares of common stock.
Price-earnings (PE) ratio.
Price of one share of stock divided by the earnings per
share of stock over the last 12 months.
A low price-earnings ratio means a stock could
be a good investment.
Beta
An index that compares risk of a specific stock with risk
of the market in general
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Investment Theories
Fundamental theory
Based on the assumption that a stock’s
intrinsic or real value is determined by
the company’s future earnings.
Fundamentalists consider the…
• Financial strength of the company.
• Type of industry company is in.
• New-product development.
• Economic growth of the overall
economy.
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Investment Theories
Technical theory
Based on the assumption that a stock’s value is
determined by the forces of supply and
demand in the stock market as a whole.
Not based on expected earnings or the intrinsic
value of a stock but rather on factors found in
the market as a whole.
Chartists plot past price movements and other
market averages to observe trends they used
to predict a stock’s future value.
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Investment Theories
Efficient market theory
Sometimes called the random walk theory.
Based on the assumption that stock price
movements are purely random.
A stock’s current market price reflects its
true value.
It is impossible for an investor to
outperform the average for the stock
market as a whole over a period of time.
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Learning Objective # 4
Describe how stocks are
bought and sold.
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Primary Market for Stocks
A market in which an investor purchases
financial securities via an investment bank,
or other representative, from the issuer of
those securities.
An investment bank is a financial firm that
assists corporations in raising funds usually
by helping to sell new security issues.
An IPO occurs when a corporation sells
stock to the general public for the first time.
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Secondary Market for Stocks
A market for existing financial securities that are
currently traded among investors.
A marketplace where member brokers who represent
investors meet to buy and sell securities.
The securities sold at an exchange must be listed, or
accepted for trading, at the exchange.
Toronto Stock Exchange or Canadian Venture Exchange
The Over-the-Counter (OTC) market.
Network of dealers who buy and sell the stocks of
companies not listed on a securities exchange;
NASDAQ (an electronic marketplace)
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Brokerage Firms
and Account Executives
An account executive, or stockbroker,
is a licensed individual who buys and
sells securities for his or her clients.
Churning.
Excessive buying and selling of
securities to generate commissions.
Discount broker versus full service brokers.
Cost of research material
Help in making decisions
Ease of buying and selling
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Stock Transactions
A market order is a request to buy or sell
stock at the current market value.
A limit order is a request to buy or sell a stock
at a specified price or price range.
A stop order is a request to sell a stock at the
next available opportunity after its market
price reaches a specified amount.
A discretionary order lets the account
executive decide when to execute the
transaction and at what price.
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Stock Transactions
(continued)
Computerized transactions.
Discount brokerage firms and some full
services brokerage firms allow investors to
trade online.
It can make the process cheaper and faster.
Commission charges.
Wide range depending on the amount of
service.
Round lot is 100 shares or multiples of 100
shares. An odd lot is fewer than 100 shares.
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Securities Regulation
To ensure full, true and plain disclosure of
all facts by sellers of securities
Provincial Regulation
Registration
Disclosure
Enforcement
Self Regulatory Organizations
Are responsible for industry conformity with
securities legislation
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Learning Objective # 5
Explain the trading techniques
used by long-term investors
and short-term speculators.
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Long-Term and Short-Term
Investment Strategies
Long-term techniques.
Buy and hold technique.
Dollar cost averaging.
Direct investment and dividend
reinvestment.
Short-term techniques.
Buying stock on margin (borrowing
money).
Selling short (borrowing stock).
Trading in options.
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