© 2013 pearson education, inc. all rights reserved.13-1 chapter 13 investing in stocks
TRANSCRIPT
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Chapter 13
Investing in Stocks
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Why Consider Stocks?
• When you buy common stock, you purchase a part of the company.
• Returns:– Dividends—the company’s distribution of profits
to stockholders.
– Capital appreciation—the increase in the selling price of a share of stock.
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Why Consider Stocks?
• Neither dividends nor capital appreciation is guaranteed with common stock.
• Dividends are paid at the board’s discretion.
• Capital appreciation takes place when the company does well.
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Why Consider Stocks?
• Over time, common stocks outperform all other investments.
• Stocks reduce risk through diversification.
• Stocks are liquid.
• Growth is determined by more than interest rates.
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Figure 13.1 Growth of $100 Invested in Different Asset Classes, 1951–2010
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The Language of Common Stocks
• Limited Liability
• Claim on Income– Declaration date– Ex-dividend date
• Claim on assets
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The Language of Common Stocks
• Voting Rights– Proxy
• Stock Splits
• Stock repurchases
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Stock Indexes: Measuring the Movements in the Market
• Stock Market Index—a measure of performance of a group of stocks that represent the market or a sector of the market.
• Dow Jones Industrial Average (DJIA) or Dow
• Standard & Poor’s 500 (S&P 500) and other indexes
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Figure 13.2 The Dow Jones Industrial Average (DJIA) Since 1990
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Market Movements
• Bear market—characterized by falling prices.
• Bull market—characterized by rising prices.
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General Classificationsof Common Stock
• Blue-Chip stocks
• Growth stocks
• Income stocks
• Speculative stocks
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General Classificationsof Common Stock
• Cyclical stocks
• Defensive stocks
• Large caps, mid-caps, and small caps
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Valuation of Common Stock
• The Technical Analysis Approach
• The Price/Earnings Ratio Approach
• The Discounted Dividends Valuation Model
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Technical Analysis Approach
• Focuses on demand and supply
• Uses charts and computer programs to identify and project price trends.
• Greed pushes money into a rising market.
• Fear pulls money out of a declining market.
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Technical Analysis Approach
• Interpretation of charts and graphs and mathematical calculations of trading patterns to spot trend or direction for stocks
• Of little value—cannot identify trends before they happen
• Avoid—encourages moving in and out of market instead of buying and holding.
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The Price/Earnings Approach
• P/E ratio or earnings multiple—price per share divided by the earnings per share
• Higher firm’s earnings growth rate, higher P/E ratio
• Higher investor’s required rate of return, lower P/E ratio.
• Fundamental analysis
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The Discounted DividendsValuation Model
• The value of any investment is the present value of the benefits or returns received from the investment.
• Value of a share of common stock = present value of the infinite stream of future dividends.
• Value of a common stock = dividends next year________ required rate of return – growth rate
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Why Stocks Fluctuate in Value
• Interest Rates and Stock Valuation
• Risk and Stock Valuation
• Earnings (and Dividend) Growth and Stock Valuation
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Dollar Cost Averaging
• Purchasing a fixed dollar amount of stock at specified intervals.
• Same dollar amount each period will average out the fluctuations.
• Buy more shares at a lower price, fewer shares at higher prices.
• Keeps you from trying to time the market.
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Buy-and-Hold Strategy
• Involves buying stock and holding it for a period of years.
• Avoids timing the market.
• Minimizes brokerage fees, transaction costs.
• Postpones capital gains taxes.
• Gains taxed as long-term capital gains.
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Dividend ReinvestmentPlans (DRIPs)
• Automatically reinvest the dividends in same firm’s stock without brokerage fees.
• Use a DRIP to reinvest rather than spend your dividends.
• Still pay income taxes.
• Stuck reinvesting in old company instead of new.
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Risks Associated withCommon Stocks
• Risk and return go hand in hand.
• Principle 8—can eliminate risk associated with common stock by diversifying.
• Only systematic risk remains.
• Measure systematic risk using Beta.
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Figure 13.5 The Risk–Return Relationship
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Another look at Principle 8: Risk and Return go hand in hand
• Beta—measure of how responsive a stock or portfolio is to changes in the market portfolio.
• Beta benchmark for market = 1
• Beta > 1—stock moves up and down more than market
• Beta <1—stock moves up and more less
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Risks Associated withCommon Stocks
• Short-term investments in stocks are very risky
• Holding stocks longer reduces variability of average annual return.
• Investors can afford to take on more risk as investment time horizons increase—they have more opportunities to adjust saving, consumption, and work habits.