Chapter 14 Investing in Stocks and Bonds Objectives

Chapter 14: Investing in Stocks and Bonds

Objectives n Describe stocks and bonds and how they are used by corporations and investors. n Define everyday terms in the language of stock investing. n Classify stock according to their basic descriptive categories.

Objectives n Describe the major characteristics of bonds. n Differentiate among the four general types of bonds.

Objectives n Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity. n List the advantages and disadvantages of investing in bonds.

Stocks and Bonds and How They are Used n Common stock n Preferred stock n Bonds

Investing in Stocks n Why do corporations issue common stock? w To raise money to start or expand a business w To help pay for ongoing business expenses w They don’t have to repay the money w Dividends are not mandatory w Stockholders have voting rights

Why Do Investors Purchase Stock? n Income from dividends n Dollar appreciation of stock value n Increased value from stock splits

Common vs. Preferred Stock n Common stock w get dividends depending on profit the company makes n Preferred stock w receive cash dividends before common stock holders w pre-determined dividend rate w most preferred stock is callable

Features of Preferred Stock Cumulative preferred stock w unpaid cash dividends accumulate and are paid before cash dividends to common stock holders n Participation feature w rare form of investment w can share in earnings beyond stated dividend amount n Conversion feature w can be traded for shares of common stock n

How to Evaluate a Stock n Read stock quotes in a newspaper, such as the Wall Street Journal w 52 week high and low w stock abbreviation and symbol w dividends per share in the last 12 months w percent yield w price earnings ratio w volume w high and low for the day w closing price and net change

Language of Stock Investing n Earnings per share (EPS) n Price/earnings ratio (P/E ratio) n Cash dividends per share n Dividend payout ratio n Market price

Language of Stock Investing n Price/sales ratio (PSR) n Book value and price-to-book ratio n Par value n Total return

Language of Stock Investing n Preemptive rights n Stock dividends n Stock splits n Voting rights

Classifications of Common Stock n Income stocks n Growth stocks n Speculative stocks n Other characterizations

Types of Stock Investments Blue chip stock w low risk w consistent dividends w ex. AT&T, Kellogg's, General Electric n Income stock w higher than average dividends w ex. utility stock n

Types of Stock Investments (continued) n Growth stock w earns above average profits w low or no dividends w Profits reinvested in company, so. . . w Stock price should go up w ex. Microsoft or Intel

Types of Stock Investments (continued) Cyclical stock w follows business cycles of advance and declines in the economy w ex. new construction, cars, timber n Defensive stock w remains stable even if the economy is declining w ex. food and utility stocks n

Stock Advisory Services A good supplement to information in newspapers n Charge a fee n Hundreds to choose from n w Standard and Poor’s reports w Value Line w Moody’s Handbook of Common Stock n On-line services allow access to web sites such as quote. yahoo. com and smartmoney. com

Numeric Measures to Consider When Evaluating a Stock n Look at book value of one share w net worth of company divided by the number of outstanding shares w if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development

Numeric Measures to Consider When Evaluating a Stock (continued) Look at the price earnings ratio w also called the P-E w price of one share of stock divided by the earnings per share of stock over the last 12 months w a low number means could be a good time to buy it, however many technology stocks have high P-Es n Look at the beta for the stock with a beta >1. 0 means more volatility n

Language of Bond Investing n Indenture n Face value, coupon rate, maturity date n Secured and unsecured n Senior and subordinated

Language of Bond Investing n Registered and bearer n Callable n Warrants n Convertibility

Types of Bonds n Corporate bonds n U. S. government securities w Treasury bills, notes, and bonds w Federal agency issues n Municipal Bonds

Considerations Before Investing in Bonds n Susceptibility to certain risks w Credit w Callability w Inflation w Interest rate

Considerations Before Investing in Bonds n Premiums and discounts n Current yield n Yield to maturity n Tax-equivalent yields n When to sell

Formula 14. 2

Formula 14. 3

Advantages of Investing in Bonds n Pay higher interest rates than savings n Offer safe return of principle n Have less volatility than stocks n Offer regular income n Require smaller initial investment

Disadvantages of Investing in Bonds n No hedge against inflation n Can be quite volatile n Compounding is almost impossible n Subject to investors tax rate n Poor marketability

Make a Decision to Sell Stocks n n n n 1. Stock reaches target price. 2. Favorable development temporarily push up price. 3. Good profits unlikely to continue. 4. Stock lags behind others in industry group. 5. Company profits begin to fall short of projections. 6. Industry/company prospects are deteriorating. 7. Losses are moderate. 8. Stock’s price/earnings ratio appears too high.