Learning Objective # 3

Explain how you can evaluate stock investments.

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Stock Valuation

Important to understand different approaches used by experts to analyze stocks

Fundamental Analysis A way to value stocks by looking at micro and

macro factors that might influence the economic value of stocks

Technical Analysis The idea that changes in investor sentiment are

responsible for changes in trends, and that the value of a stock can be predicted by extrapolating price from historical patterns

Efficient Market Hypothesis States that future prices cannot be predicted from

past trends and patterns

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Classification of Stock Investments

Blue chip stock Safe investment in strong and respected companies Attracts conservative investors ex. Bell Canada, Royal Bank

Income stock Pays higher than average dividends, ex. utility stock

Growth stock Earns above average profits of all firms in the economy. Less than 30% of earnings are paid out as dividends,

with rest reinvested in research & development ex. Southwest Airlines, Home Depot

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Classification of Stock Investments Cyclical stock

Follows the business cycle of advances and declines in the economy

ex. automobiles, timber, and steel Defensive stock

Remains stable during declines in the economy

ex. Kellogg, Procter & Gamble and utility stocks

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Classification of Stock Investments

Large cap stocks Issued by a large corporation that has a

large amount of stock outstanding & a large amount of capitalization

Capitalization The total amount of securities--stocks and

bonds--issued by a corporation Small cap stocks

Issued by a company that has a capitalization of $150 million or less

Penny Stocks Typically sell for less than $1 per share

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Sources of Information on Stocks

Newspapers The Internet Stock Advisory Services

Charge a fee Hundreds to choose from

Corporate News Disclose information about corporate

earnings, assets and liabilities, products or services

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Factors that Influence the Price of Stocks

Bull market Investors are optimistic about nation’s

economy More investors are buying stock and the

stock market increases Bear market

Investors are pessimistic about economy More investors are selling stock so and

the stock market declines

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Measures of Corporate Risk, Performance and Shareholder’s Return

Annual Shareholder’s Return A stock’s annual dividend and increase in

value divided by its beginning-of-year stock price

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Annual Shareholder = Annual Dividend + Appreciation in Value

Return Initial Stock Investment

Measures of Corporate Risk, Performance and Shareholder’s Return

Dividend Yield A stock’s annual dividend divided by its

beginning-of-year stock price If the dividend is divided by the end-of-year

stock price, it is referred to as its trailing dividend yield

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Annual Dividend Yield = Annual Dividend

Initial Stock Investment

Measures of Corporate Risk, Performance and Shareholder’s Returns

Capital Gains Yield A stock’s increase in value divided by its

beginning-of-year stock price

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Capital Gains Yield = Appreciation in Value

Initial Stock Investment

Measures of Corporate Risk, Performance and Shareholder’s Returns Earnings Per Share

Are the corporation’s after tax-earnings divided by the number of outstanding shares of common stock

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Earnings Per Share = After-Tax Earnings

Number of outstanding shares

of common stock

Measures of Corporate Risk, Performance and Shareholder’s Returns Price-Earnings (PE) Ratio

Price of one share of stock divided by the earnings per share of stock over the past 12 months

A low price-earnings ratio means a stock could be a good investment

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Price-Earnings Ratio = Price Per Share

Earnings per share of stock

Outstanding over the last 12 months

Measures of Corporate Risk, Performance and Shareholder’s Returns Beta

Is an index that compares the risk associated with a specific stock issue with the risk of the stock market in general

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