Common Stock Basics-1

8/6/2019 Common Stock Basics-1

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Common Stock BasicsCommon Stock Basics1. Definition : Stocks are A type of security that signifies ownershipin a corporation and represents a claim on part of the corporation'sassets and earnings.2. Types : Common Stock (usually entitles the owner to vote atshareholders' meetings and to receive dividends). Preferred(generally does not have voting rights, but has a higher claim onassets and earnings than the common shares). Class A :A classification of common stock that may be accompanied bymore voting rights. Class B: a classification of common stock thatusually does not have as many or may not have any voting rights to

elect officers to the Board of Directors of a Corporation.3. Represents OWNERSHIP in the Corporation.


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Common Stock BasicsCommon Stock Basics4 . Owners are also referred to as shareholders or equity owners .5. Street name : A brokerage account where the customer's

securities and assets are held in the name of the brokerage firm,rather than you holding the stock certificate yourself. The customer is still listed as the real or beneficial owner.6. Board of Directors : A group of individuals that are elected as, or elected to act as, representatives of the stockholders to establishcorporate management related policies and to make decisions onmajor company issues. Such issues include the hiring/firing of executives, dividend policies, options policies and executivecompensation. Every public company must have a Board of Directors.


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V aluation of Common Stock V aluation of Common Stock 2. Capital Asset Pricing Model

A model that describes the relationship between risk and expected return and that is

used in the pricing of risky securities .

The CAPM says that the expected return of a security or a portfolio equals the rate on arisk-free security plus a risk premium. If this expected return does not meet or beat therequired return, then the investment should not be undertaken. The security market lineplots the results of the CAPM for all different risks (betas).


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T he Panic of 1987 T he Panic of 1987 Index arbitrage and portfolio insurance (programmed trading)were the major cause. From Tuesday 10/13/87 to 10/19/87,the DJIA fell 769 points or 31%. On 10/19/87 the DJIA fell508points or 22.6%. On 10/28/29 the DJIA fell 11.7%.

Mutual funds and pension funds use portfolio insurance.Portfolio insurance is a strategy that uses computer basedmodels to determine an optimal stock/cash ratio at variousmarket prices. Two insurance users called for sales equaling50% in response to a 10% decline in the S&P 500 Index.


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Stock Market BasicsMost stocks are traded on exchanges, which are places where buyersand sellers meet and decide on a price. Some exchanges are physicallocations where transactions are carried out on a trading floor.The purpose of a stock market is to facilitate the exchange of securitiesbetween buyers and sellers, reducing the risks of investing.


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Stock Market Basics

The primary market is where securities are created (by means of an IPO)while, in the secondary market , investors trade previously-issuedsecurities without the involvement of the issuing-companies. The

secondary market is what people are referring to when they talk about thestock market. It is important to understand that the trading of acompany's stock does not directly involve that company.

The most prestigious exchange in the world is the New York StockExchange (NYSE ). The "Big Board" was founded over 200 yearsago in 1792 with the signing of the Buttonwood Agreement by 2 4 New York City stockbrokers and merchants. Currently the NYSE,with stocks like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and Wal-mart, is the market of choice for the largestcompanies in America.

Types of Markets


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Stock Market Basicsthe O T C and Nasdaq

The second type of exchange is the virtual sortcalled an over-the-counter (OTC ) market, of whichthe Nasdaq is the most popular. These markets

have no central location or floor brokerswhatsoever. Trading is done through a computer and telecommunications network of dealers. Itused to be that the largest companies were listedonly on the NYSE while all other second tier stockstraded on the other exchanges. The tech boom of

the late '90s changed all this; now the Nasdaq ishome to several big technology companies suchas Microsoft, Cisco, Intel, Dell and Oracle.


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Stock Market Basicsthe AMEX

The third-largest stock exchange by tradingvolume in the United States. The AMEX is locatedin New York City and handles about 10% of allsecurities traded in the U.S.The AMEX has now merged with the Nasdaq. It wasknown as the "curb exchange" until 1921.It used to be a strong competitor to the New YorkStock Exchange, but that role has since been filledby the Nasdaq. Today, almost all trading on theAMEX is in small-cap stocks, exchange-tradedfunds and derivatives.


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Stock Market BasicsReading Stock Quotes

Columns 1 & 2: 52-Week High and Low - These are the highest and lowest prices at whicha stock has traded over the previous 52 weeks (one year). This typically does not includethe previous day's trading.

Column 3: Company Name & Type of Stock - This column lists the name of the company.If there are no special symbols or letters following the name, it is common stock.Different symbols imply different classes of shares . For example, "pf" means the sharesare preferred stock.

Column 4 : Ticker Symbol - This is the unique alphabetic name which identifies the stock.If you watch financial TV, you have seen the ticker tape move across the screen, quotingthe latest prices alongside this symbol. If you are looking for stock quotes online, youalways search for a company by the ticker symbol. If you don't know what a particular company's ticker is you can search for it at: http://finance.yahoo.com/.


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Stock Market Basics

Reading Stock Quotes

Column 5: Dividend Per Share - Th is indicates t h e annual dividend payment per s h are. If t h is space isblank, t h e company does not currently pay out dividends.

Column 6: Dividend Yield - Th e percentage return on t h e dividend. Calculated as annual dividends per s h are divided by price per s h are.

Column 7: Price/Earnings Ratio - Th is is calculated by dividing t h e current stock price by earnings per s h are from t h e last four quarters. For more detail on h ow to interpret t h is, see our P/E Ratio tutorial.Column 8: Trading Volume - Th is figure s h ows t h e total number of s h ares traded for t h e day, listed inh undreds. To get t h e actual number traded, add "00" to t h e end of t h e number listed.

Column 9 & 10: Day High and Low - Th is indicates t h e price range at w h ich th e stock h as traded atth roug h out t h e day. In ot h er words, t h ese are t h e maximum and t h e minimum prices t h at people h ave paidfor t h e stock.


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Stock Market BasicsReading Stock Quotes

Column 12: Net Change - Th is is t h e dollar value c h ange in t h e stock pricefrom t h e previous day's closing price. W h en you h ear about a stock being

"up for th

e day," it means th

e net ch

ange was positive.Q uotes on the InternetNowadays, it's far more convenient for most to get stock quotes off t h eInternet. Th is met h od is superior because most sites update t h roug h out t h eday and give you more information, news, c h arting, researc h , etc.


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Stock Market Basics

TheThe use of use of " "bullbull " and "" and " bear bear " to describe markets" to describe markets comes from thecomes from theway in which each animal attacks its opponents. That is, away in which each animal attacks its opponents. That is, abullbull thrusts its horns up into the air,thrusts its horns up into the air, and a bear and a bear swipesswipes

itsits pawspaws down. These actionsdown. These actions are metaphors for are metaphors for the movement of athe movement of amarket: if the trendmarket: if the trend is up, itis up, it is considered a bull market. And if theis considered a bull market. And if thetrendtrend is down, itis down, it is considered a bear market.is considered a bear market.

The Bull marketThe Bull market is when everything in the economy is great, peopleis when everything in the economy is great, peopleare finding jobs,are finding jobs, gross domestic product (GDP) is growing, andgross domestic product (GDP) is growing, andstocks are rising. Things are just plain rosy! Picking stocks during astocks are rising. Things are just plain rosy! Picking stocks during abull market is easier because everything is going up. Bull marketsbull market is easier because everything is going up. Bull marketscannot last forever though, and sometimes they can lead tocannot last forever though, and sometimes they can lead todangerous situations if stocks become overvalued. If a person isdangerous situations if stocks become overvalued. If a person isoptimistic andoptimistic and believes that stocks will go up, he or she is called abelieves that stocks will go up, he or she is called a"bull" and is said to have a "bullish outlook"."bull" and is said to have a "bullish outlook".

Animals in theMarket


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Stock Market Basics

Bear Markets

Bear Markets characterize the attitude of investorswho believes that a particular security or marketis headed downward. Bears attempt to profit froma decline in prices. Bears are generally pessimisticabout the state of a given market. Bearishsentiment can be applied to all types of marketsincluding commodity markets, stock marketsand the bond market.


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Stock Market BasicsSelling Short

The selling of a security that the seller does notown, or any sale that is completed by the deliveryof a security borrowed by the seller. Short sellers

assume that they will be able to buy the stock at alower amount than the price at which they soldshort.Selling short is the opposite of going long. That is,short sellers make money if the stock goes down

in price.This is an advanced trading strategy with manyunique risks and pitfalls. Novice investors areadvised to avoid short sales.


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I nvesting in Equities

Common StockInvestments


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G rahams Fundamental I nvestment Rules1. Adequate Size

2. Sufficient Strong FinancialCondition3. Earnings Stability4 . Dividend Record5. Earnings Growth6. Moderate Price/Earnings Ratio7. Moderate Ratio of Price to Assets


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T erms

1. Net Current Assets (NCA) Defined as:

Current Assets- Current Liabilities- Long-Term Debt- Preferred Stock

NCA Total

NCA c = NCA/# of Common Shares


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T erms (continued)

2. Data Source S&P Stock Guide Value Line, etc.

3. Earnings Per Share (EPS)4 . Market Price5. Book Value Per Share

6. Dividends Per Share7. Current Ratio


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T erms (continued)

8. Total Debt9. Equity

10. Growth

g = [ (1 + R P,-1 )(1 + R P,-2 ) ... (1 + R P,-10 )] -

1

1/n


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T he G raham Model

1. Group A Criteria#1: E/P > 2 (AAA Yield)(1 pt.)

E/P > 1.33 (AAA Yield) (1/2 pt.)

#2: P/E < . 4 (Avg. P/E in last 3 yrs.) (1 pt.)P/E < . 4 (Avg. P/E in last 10 yrs.) (1/2 pt.)

#3: P/Bk < 2/3 (1 pt.)P/Bk < 1 (1/2 pt.)

#4 : D/P > .67 (AAA Yield) (1 pt.)D/P > .50 (AAA Yield) (1/2 pt.)

#5: P/NCA < 1 (1 pt.)P/NCA < 1.33 (1/2 pt.)


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Sir John Mark T empleton

Sir Johns 16 Rules for I nvestment Success:1. Invest for maximum total real return including taxes andinflation.

2. Invest. Dont trade or speculate.3. Remain flexible and open-minded about types of investments. No one kind of investment is always best.4 . Buy at a low price. Buy what others are despondentlyselling. Then sell what others are despondently buying.

5. Search for bargains among quality stocks.6. Buy value not market trends or economic value.7. Diversify. There is safety in numbers.8. Do your homework. Do not take the word of experts.

Investigate before you invest.


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A. Definition

Technical analysis really just studies supply and demand in amarket in an attempt to determine what direction, or trend, willcontinue in the future. In other words, technical analysisattempts to understand the emotions in the market bystudying the market itself, as opposed to its components. If

you understand the benefits and limitations of technicalanalysis, it can give you a new set of tools or skills that willenable you to be a better trader or investor.

T echnical Analysis is the belief that

important information about futurestock price movements can beobtained by studying the historicalprice movement.

1st Q tr 2nd Q tr 3rd Q tr 4 th Q tr 0

10

20

30

4 0

50

60

7080

90

1st Q tr 2nd Q tr 3rd Q tr 4 th Q tr


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Assumptions

1. The Market Discounts Everything

technical analysis assumes that, at any given time, a stock'sprice reflects everything that has or could affect the company- including fundamental factors. Technical analysts believethat the company's fundamentals, along with broader economic factors and market psychology, are all priced intothe stock, removing the need to actually consider thesefactors separately. This only leaves the analysis of pricemovement, which technical theory views as a product of thesupply and demand for a particular stock in the market.


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Assumptions

2. Price Moves in TrendsIn technical analysis, price

movements are believed to follow trends.This means that after a trend has beenestablished, the future price movement ismore likely to be in the same direction asthe trend than to be against it. Mosttechnical trading strategies are based onthis assumption.


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Assumptions

3. History Tends To Repeat Itself

Another important idea in technical analysis is that historytends to repeat itself, mainly in terms of price movement. Therepetitive nature of price movements is attributed to marketpsychology; in other words, market participants tend toprovide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyzemarket movements and understand trends. Although many of these charts have been used for more than 100 years, theyare still believed to be relevant because they illustrate

patterns in price movements that often repeat themselves.


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Tec h nical Analysis Assumptions:

Technical analysts base their buy and selldecisions on the charts they prepare of recordedfinancial data

1. Market value is determined by the interaction of supplyand demand.

2. Supply and demand are governed by numerous factors,both rational and irrational.

3. Security prices tend to move in trends that persist for anappreciable length of time, despite minor fluctuations inthe market.

4. Changes in a trend are caused by shifts in supply anddemand.

5. Shifts in supply and demand, no matter why they occur,can be detected sooner or later in charts of markettransactions

6. Some chart patterns tend to repeat themselves.


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T ypes of T echnical Charts:

Bar Charts

Tradi ng D ays

Doll arPrice of

Sto ck

H

L

C


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T ypes of T echnical Charts:

Line Charts: a graph of successive daysclosing prices

Tradi ng D ays

C losingPrices


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B. Approaches to T echnical Analysis

1 . Th e Dow Th eory The Dow theory views the movement of market

prices as occurring in three categories1. P rimary Movements: bull and bear markets2.Secondary Movements: up and downmovements of stock prices that last for a few

months and are called corrections3. Daily Movements: meaningless random dailyfluctuations


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B. Approaches to T echnical Analysis (continued )

2. Trading Action a. Concentrates on minor trading

characteristics in the market b. Examples include:

1. Monday is the worst day to buy stocks,

Friday is the best.2. If January is a good month for themarket then chances are good a good year will occur.


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B. Approaches to T echnical Analysis (continued )

3. Bellwether Stocks a. A few major stocks in the market are

consistently highly accurate inreflecting the current state of themarket.

IBM

DuPontAT&TExxonGM


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Approaches to T echnical

Analysis (Continued):4 . Relative Strength The basic idea behind relative strength

is that some securities will increasemore, relative to the market, in bullmarkets and decline less, relative tothe market, in bear markets.Technicians believe that by investing inthose securities that exhibit relativestrength higher returns can be earned.


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B. Approaches to T echnical Analysis (continued)

5. Technical Indicators a. Market Volume -- a measure of investor

interest1. STRONG when volume goes up in rising

market or drops during declining market2. WEAK when volume goes up in decliningmarket or decreases during a rally


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B. Approaches toT

echnical Analysis (continued) Example

On June 3, 2003 Advances = 930 Declines = 691 Difference = + 239

On June 11, 2003 Advances = 651 Declines = 920 Difference = -269

Conclusion: A weak market.


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b. Breadth of the Market1. Considers the advances anddeclines in the market.2. As long as advances outnumber

declines a strong market exists.3. The spread is used as anindicator of market strength.


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c. Short Interest -- measures the number of stockssold short

When the level of short interest is high, by historicalstandards, then the situation is optimistic.

d. Odd-Lot Trading: Theory of Contrary Opinion

If the amount of odd-lot purchases start to exceed odd-lotsales by a widening margin, it may suggest thatspeculation is occurring among small investors. This isthe first signal of an upcoming bear market.


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Review Questions: Section 3What are two theoretical ways to determine the value of Common Stock?Net Current Asset in the Graham model is defined as?

Why do we calculate geometric instead of linear growthrates?The Graham model is a fundamental valuation model?Explain.Define technical analysis.

What are Bellweather stocks?Who was Peter Lynch and what is he primarily known for?What are Lynchs 10 golden rules for investing?

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