1 Chapter 13 - Stock • Purchase stock = buy part of company • Returns from dividends and capital appreciation – Dividends – distribution of profits – Neither dividends nor appreciation guaranteed • Why invest in stocks? – Over time, outperform other investments, provide diversification, and are liquid
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1 Chapter 13 - Stock Purchase stock = buy part of company Returns from dividends and capital appreciation –Dividends – distribution of profits –Neither.
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Chapter 13 - Stock
• Purchase stock = buy part of company• Returns from dividends and capital
appreciation– Dividends – distribution of profits– Neither dividends nor appreciation guaranteed
• Why invest in stocks?– Over time, outperform other investments,
provide diversification, and are liquid
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Annual Rates of Return1926 to 2000
Avg Ann Stand RiskSecurity Returns Dev PremSmall Co Stocks 17.3% 33.4% 13.4%Common Stock 13.0 20.2 9.1L-T Corp Bonds 6.0 8.7 2.1L-T Govt Bonds 5.7 9.4 1.8Med-term Govt 5.5 5.8 1.6US T-Bills 3.9 3.2 0Inflation 3.2 4.4
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Terminology
• Limited liability – stockholder not liable for firm's debts
• Claim on income (after all expenses paid) but board decides to pay dividends
• Dividends – 75% pay, usually quarterly• Voting rights – shareholders elect directors
and approve changes in governing rules– Vote through proxies
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Proxy Statement
Proxy – gives instructions on how to vote your shares
Annual meeting – elect some directors, appoint auditors; sometimes approve option plans, new shares, merger, etc
Statement – discusses directors, executive comp, stock performance versus index
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Terminology II
Splits – new shares issued on pro rata basis– No economic impact
Share repurchases returns funds to shareholder; accomplishes other objectives
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Stock Indexes
• Measure general market performance– DJIA (30 companies), S&P 500 and others
• Stock prices now decimalized; previously fractions of a dollar
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Classifications
• Blue-chips
• Growth stocks
• Speculative issues
• Cyclical stocks
• Defensive stocks
• Large caps
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Valuing Stocks
• Technical analysis – supply and demand; charts used to predict trends– Author: Little value, other strong believers
• Price/ earnings ratios– Price / EPS – forward and backward looking– Positive about prospects, have high P/E– Dividend yield – about 1.6%
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Top-Down Analysis
Economic Industry Fundamentals
Economic Analysis
Fiscal & Monetary, Other (inflation, etc)
Industry as a whole: Growing?
Competitive? Technology? Cyclical?
Company Fundamentals - Performance and position in industry, results
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Discounted Dividend Valuation
• Present values all future dividends– Dividends – an infinite stream– Assumed to grow at constant rate forever– Need to estimate future dividends and investors'
required rate
• Market value = Dividend Next Year Required rate less growth rate
• How can you value a non-dividend stock?
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Why Stocks Fluctuate
• Interest rate changes– Inverse relation between rate change and
price change– Rates rise, present value of dividend and
price both fall
• Risk – more risky, price falls
• Outlook for company and economy.
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Common Sense Advice
• Don'ts when stocks tumble:– Don't make impulsive decisions– Don't ignore taxes– Don't listen to pundits– Don't count you losses because they are
meaningless until you sell.
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Strategies
• Dollar cost averaging – buy fixed amount at regular intervals
• Buy and hold – Why?– Can't time the market, minimizes broker fees
• Dividend Reinvestment Plans (DRIP's)– Dividends automatically reinvested in the stock– Taxed on dividend even if get no cash
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Stocks and the 15 Principles
#1. Risk-return tradeoff – stocks on the upper end of the risk/return line
#3 Diversification reduces risk – find investments that don't move together
#4 Not all risk is equal – can reduce company specific risk but not market risk
#11 Time – long horizon, can take more risk. See Figure 13.7