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Module 5Stocks

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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?

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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 PerformedAnnual Total Returns 1971-2000

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50%

1971

1972

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T-Bill Total Return

Government Bonds Total Return

Stocks Total Return

Source: Global Financial Data www.globalfindata.com

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Here’s another way of looking at how stocks performed

Annual ReturnCash

(90 day T-Bill)Bonds

(TreasuryBond)

Stocks(S&P 500)

Average for 1970-2000

6.7% 9.9% 14.5%

Maximum 15.2% 44% 37.7%Minimum 3.1% -7.3% -27%StandardDeviation

2.7% 9.3% 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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IBM Common versus IBM Preferred

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($

) 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

• 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.

Number of IPOs

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100

200

300

400

500

600

700

800

900

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

AMEX

NYSE

NASDAQ

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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 2000

Number of shares traded a year 204 B 262.5 B

Market value of companies $14 T $12.4 T

Average price per share $27.50 $37.61

Number of companies 2759 2862

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National Association of Securities Dealers Automated Quote System NASDAQ

NASDAQ

2006 2000 Number of shares traded per year 273 B 443 B

Market value of companies $5.2 T $3.6 T

Average price per share $31.64

Number of listed companies 3200 4734

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American Stock Exchange (AMEX)

American Stock Exchange

2006 2000 Number of shares traded 20 B 13 B

Market value of companies $570 B $125 B

Average price per share $55.85

Number of listed companies 1433 765

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Types of Shares and Dilution

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Types of Investors

Banks2.0%

Households38.3%

Brokers and Dealers0.4%Funds

19.1%

Public Pension Funds11.3%

Private Pension Funds11.6%

Insurance Companies6.5%

Foreign Investors10.0%

Government0.7%

Who Owns Stock

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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Dow Jones Industrial Average (DJIA)

Oldest and most well-known stock index.

Covers 30 very large companies.

Price-weighted index so the stock with the highest price (IBM) has the most influence.

Large Cap Index - Dow Jones Industrial Average

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10%

20%

30%

40%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Annual Return

S&P 500

DJIA

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Standard and Poor’s 500 - Large Cap

500 largest stocks

Market value-weighted index. GE, Exxon Mobil, Microsoft, Citigroup, and Pfizer are the largest companies

Used as an index for large companies

Large Cap Index - S&P 500

-60%

-40%

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0%

20%

40%

60%

80%

100%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Annual Return

S&P 500

Russell 2000

NASDAQ Composite

S&P 400

DJIA

Wilshire 5000

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Russell 2000 - Small CapAlso S&P 600

Take the top 3000 companies and select the bottom 2000

Russell 2000 is the index for small cap companies

Small Cap Index - Russell 2000

-30%

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10%

20%

30%

40%

50%

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Annual Return

S&P 500

Russell 2000

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Wilshire 5000 - Total Market

All U.S. (7000) companies listed on the exchanges

True index for total stock market

Total Market Index - Wilshire 5000

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0%

10%

20%

30%

40%

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Annual Return

S&P 500

Wilshire 5000

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Standard and Poor’s 400 - Mid Cap

Next 400 stocks after the S&P 500

Measure of medium cap stocks

Mid Cap Index - S&P 400

-20%

-10%

0%

10%

20%

30%

40%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Annual Return

S&P 500

S&P 400

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Other Indices

Annual Returns of Selected Asset Classes

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0%

10%

20%

30%

40%

50%

2002 2003 2004 2005 2006

PhiladelphiaGoldSilver

S&P Midcap

Russell 2000 SmallCap

S&P 500

EAFE InternationalDeveloped

NAREIT RealEstate

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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