Common Stock Investing

1. Common Stock Investing Gitman-Joehnk Chapter 5

2. Key Concepts • Appeal of Common Stocks • Historical Performance of Common Stocks • Advantages & Disadvantages of CS • Key Characteristics of CS • Buying and Selling CS • Reading Stock Quotes • Transactions Costs • Common Stock Values • Dividends • Alternative CS Investment Strategies • Classification of Stocks by Type

3. Basic Characteristics Each share of common stock represents ownership/equity in the company. Generally implies equal participation in: earnings dividends vote voice in management unless there are different classes of stock

4. Common Stock as a corporate security: All corporations must issue shares of common stock. Common stock in most companies is never traded: firm is so small that there is no need or market for its CS company is family owned and controlled

5. In publicly traded companies, common stock can be issued in several ways: public offering rights offering stock split treasury stock classified common stock

6. Basic Appeal of Common Stock: • enables investors to participate in the profits of a firm • CS shareholders are residual owners of the company • entitled to • dividend income • share of company’s earnings, but only after • all other corporate obligations have been • met • offers no guaranteeof a specific return on CS • investment • The Challenge is to find stocks that provide the kind • return desired by the investor

7. CS investments can be tailored to meet individual • needs and preferences given size and • diversity of capital markets • potential access to • steady income (through dividends) • wealth accumulation (capital gains)

8. Advantages and Disadvantages: Advantages: can provide highly competitive and attractive returns CS - over last 40 years ~ 10% per year over last 5-10 years ~ 10-15% per yr. Corp Bonds - over last 40 years 6% per yr. or less than 2/3’s the return on CS CS shareholders fully participate in residual profits

9. (Advantages ) easy to buy and sell transactions costs modest price & market information widely disseminated unit cost of shares usually in reach of most investors bonds often $5-10,000 denom. mutual funds often require-$500-$1,000 to open acct.

10. Disadvantages: • biggest is the higher relative risk • company earnings are subject to volatility • from many factors that impact sales, • revenues, profits • wide fluctuations in performance make • CS hard to value and, therefore, • hard to consistently choose top performers • future performance is always uncertain • valuation methods are imperfect

11. (Disadvantages) • CS lags behind many other investments in producing • current income • CS vs. Bonds- dividend yields almost always • trail coupon yields

12. Historical Performance (return): T-Bills : 3.7% LT Bonds: 4.8% Stock : 10.3% Stocks vs. Bonds: Holding Period 1926-95 (in yrs.) 1 60% 5 77% 10 89% 20 98% 30 100%

13. Historical Performance (risk): The stock market remains a risky place to invest. Odds on losing money over various holding periods as measured by the S&P 500 stock index: Holding Period probability of loss 1 26% 3 14% 5 10% >10 3%

14. Stock Quotes: Investors rely on highly efficient information system to disseminate market prices to the public. thus CS price quotations are essential Most stock quotations use standard format and symbolic language. Consider the WSJ Stock Tables as an Example

15. WSJ example table goes here.

16. Common Stock Values: Par Value - stated or face value of a share of CS not a measure of anything except used in accounting as a result, many stocks today are issued as no par low par with par values of 1 to 2cents

17. Book Value - accounting measure representing the amount of stockholders’ equity in the firm. BVE = BVA - BVL - BVPS where BVE=book value of equity (common stock) BVA=book value of assets BVL= book value of liabilities BVPS= book value of preferred stock on a per share basis: BVEper share=BVE/NSO

18. Market Value-easiest of the common stock values to find since it reflects the prevailing market price at any point in time. Thus market value is synonymous with the concensus view of the Fair Mkt. Value Total market capitalization is the product of market value and NSO

19. Investment Value - most important measure for an investor/stockholder indicates the worth the investor places on the stock i.e. what investors think the stock “should” sell at determining this value is fairly complex based upon expectations of the risk-return behavior of the stock

20. More on investment value: D is dividend per share P is investment value (per share) dpr is dividend payout ratio EPS is earnings per share ri is the required rate of return t is time period t *all are expectations concern- ing future values

21. Thus investment value depends on the expected or required rate of return and the cash payouts (primarily dividends) the investor expects to receive in the future. Market places high value on dividends if a company is going to retain earnings, it should demonstrate proportionately higher growth and profit levels if the company is investing funds at a high rate of return then retention is OK -- otherwise the company should pay out profits to shareholders.

22. Dividends: As discussed, dividends are one of two basic sources of return to common stock dividends are generally paid on a quarterly basis amount decided by Bd of Dir Bd evaluates the firm’s operating results and financial conditions to establish amount to be paid and the dates of payment One key variable is EPS - which translates corp. profits into profits per share providing a convenient measure of the earning that are available to stockholders

23. Dividends (more) Much of earnings may be needed to finance growth so future growth prospects will need to be assessed Cash position is important - must be sufficient liquidity to meet a cash dividend of the announced size. Bd. must meet all legal & contractural constraints limit its ability to pay dividends

24. Key Dates: Date of Declaration - The company’s board of directors announces that a dividend will be paid on a certain date in the future.

25. Key Dividend Dates: Date of Record - date on which the investor must be a registered shareholder of the firm to receive a dividend Payment Date - generally follows the date of record by 1-to-2 weeks. It is the actual date on which the dividend checks will be mailed to holders of record Ex-Dividend Date - this date will dictate whether a shareholder is an official shareholder. If you sell stock 0n-or-after the ex-dividend date you receive the dividend necessary from a bookkeeping standpoint

26. Example Chronology: January 3rd - Date of Declaration January 13th - Ex-Dividend Date January 18th - Date of Record January 28th - Payment Date

27. Form of Dividend Payment Cash Stock - has no real value, represents the receipt of something you already own (more shares, lower share price) DRIP - Dividend reinvestment plans dividends automatically reinvested into additional shares of a company’s stock usually no commission taxed as ordinary income in year received

28. Alternative Investment Strategies Common Stocks can be used for *store of value - emphasis on safety and protection of principal Blue Chips nonspeculative, high quality stocks *accumulation of capital (wealth) important goal for those with long-term investment horizons use capital gains and dividends to build wealth target both growth and income stocks

29. *source of income - emphasize dependable flow of dividends high yielding, good quality income stocks (dividend yields are important here

30. Strategies Buy-and-Hold High Income Quality LT Growth Aggressive Stock Management Speculative and ST Trading

31. Kinds of Stocks Blue Chip- large, well established, financially sound Income- sustained record of paying above avg. dividends Growth-sustained, high growth rate of operations and earnings (15-18%) usually low-to-no dividends Speculative- lacks sustained records of success but offers potential capital gains; often involves anticipation of a change Cyclical- stock price moves with business cycle Defensive- stock price is stable or counter-cyclical Mid-Cap- $500m. <MVE<$2-3 b. Small-Cap- MVE < $500 m. Large-Cap- MVE> $2-3 b.