Chapter 6- Common Stocks Flashcards
Residual Owners
- stockholders of a firm are the owners, who are entitled to dividend income and a pro rated share of the firms earnings
The Appeal of Common Stocks
- greatest potential for gain - share of firms earnings - the ultimate risk bearers - hope to gain from an increase in share price and income from dividends - always a relationship in risk and return, the higher the return the higher the risk, never get a return that is risk free - as interest rates decline, bonds go up - as price goes down so do interest rates
Common Stock Basics
- usually possess voting power amongst the company - permit proxy voting, can give your vote to somebody else and they can vote your shares, can generate power by gathering a lot of votes - some possess the preemptive right, you get first oppurtunity to buy additional shares, buy up to 10% of those shares - may be different classes of stock in a company, example being class A could have voting rights while class B does not
Dividends
- one of the ways to get earnings from common stock that you own - taxed at max rate of 15%, same as capital gains on stock you own - recieve preferential tax treatment (as do capital gains) - key dates for dividends- declaration date, date of record, ex dividen rate, payment date - if you pay on ex dividend rate, will not be holder of record
Dividend Yield
- a measure to relate dividends to share price on a percentage basis - indicates the current income earned on the investment dollar - conveniant method to compare income return to the other investment alternatives Yield Ratio= annual dividends recieved per share/ current price to the other investment alternatives
Three reasons to love dividends
- stocks that pay divdends tend to produce higher returns than those that do not - since 1928, dividends have accounted for 40% of the total return on stocks - since 1980, dividend-payer stocks have averaged annualized returns of 15.1% vs 12.8% for non payers
Small Cap Stocks
- Under 1 billion
Mid Cap Stocks
- 1 billion to 4-5 billion
Large Cap Stocks
- more than 4-5 billion (often referred to blue chips the biggest large cap stocks)
Going Global
- buying shares directly in foreign markets - most adventuresome approach - logistical problems: fluctuating currency rates, different regulatory and accounting standards, tax problems, “red tape”
American Depositary Receipts (ADRs)
- simpler approach - bought and sold on the US markets just like stocks in US companies - transactions are in US dollars
What determines the value of a share of stock?
- supply and demand - return
Factors Influencing Return
- Dividends and EPS - Arrival of New Information - change in capital market conditions- interest rates, risk: as investors we need to pay attention to what the FED is doing
What Information Do I want?
- Investors: Dividends and EPS, events that will increase sales and earnings - Speculators: Trying to anticpate the arrival of new information and changes in capital market conditions - Lead Time (Getting info before everyone else does)
Market Tendencies
- prices tend to change in anticpation of events - market will respond to the arrival of new information, example. Toyota annouces halt in production or Steve Jobs annoucing he was taking health leave of absence
Routine Decline
- A drop of 5% or more in one of the major market indexes, like Dow Jones Industrial Average.
Correction
- a drop of 10% or more in one of the major market indexes
Bear Market
- a drop of 20% or more in one of the major market indexes
Defensive Stock
- stocks involving something that ppl have to have; pharmaceuticals and utilities, these stock likely to do better than average
Income Stock
An equity security that pays regular, often steadily increasing dividends, and offers a high yield that may generate the majority of overall returns. While there is no specific breakpoint for classification, most income stocks have lower levels of volatility than the overall stock market, and offer higher-than-market dividend yields. Income stocks may have limited future growth options, thereby requiring a lower level of ongoing capital investment
Growth Stock
-Shares in a company whose earnings are expected to grow at an above-average rate relative to the market. -Also known as a “glamor stock”.
Cyclical Stocks
- ride the wave of the economy; automobiles, entertainment stocks
Blue Chip Stocks
-Big well-known companies, tend to have resources to weather storm that smaller companies do not have
Security Analysis
- the process of gathering and organizing information and then using it to determine the intrinsic value of a share of stock. (what stock is supposed to be worth)
Intrinsic Value
- the underlying or inherent value of a stock, as determined through fundamental analysis - a prudent investor will only buy a stock if its market price does not exceed what the investor thinks the stock is worth. - depends on several factors: estimates of future cash flows, discount rate, amount of risk.
Ben Graham two elements of stock price
- investment value: performance drive - speculative value: driven by sentiment and emotion
Fundamental Analysis
- a philosophy of whats important in determining value of a stock - mostly concerned with long range events - not considered a short term timing tool - speculators generally not interested
Government Fiscal Policy
- taxes, government spending, debt management
Monetary Policy affects business cycle
- money suppy, interest rates
Other Factors affecting business cycle
- inflation, consumer spending, business investment, foreign trade, currency exchange
Fundamental Analysis: Data Set
- Industry Statistics - Techonological Developments- how it affects industry - Management and Corporate Policies- philosophy on how to grow the company - Growth Potential- Will it expand? Will it decline? Where is the business headed? - Earnings- Past, Present, Future (future will affect company’s stocks; past will not) - Financial Statements- Balance Sheets, income statement, ratio analysis, cash flow statement
Important Points to Remember
- stock prices usually change before the acutal forecasted changes beomce apparent in the economy - stock price trends are another leading indicator often used to help predict the direction of the economy itself - example. the great recession of today pulling money out of stocks and moving them to bonds. When will they move them back to the stock market? By the time the economy improves it will be too late for stocks as the prices will have already gone up. Good stock price is dependent on great future potential when people don’t want it
Industry Analysis
- Evaluate the competitive position of a particular industry in relation to other industries; look for new oppurtunities of growth potential - Identify companies within the industry that look promising, and make sure to know what the company does; looking for strong markets postitions, pricing, leadership, economies of scale
Issues that affect the Industry
- what is the nature of the industry? - is the industry regulated? - What role does the labor play in the industry (labor costs) - How Important are Technological Developments? - Which Economic Forces (interest rates, foreign trade) affect the industry? - What are the important financial and operating considerations?
Growth Cycles and Investments
- reflectst the vitality of and industry or a company over time
Initial Development
-industry is new and risks are very high
Rapid Expansion
- Product Acceptance is growing and investors become very interested
Mature Growth
- expansion comes from growth in the economy and returns are more predictable
Stability or Decline
- demand for product is diminishing and investors avoid this stage
Goal of Investing
- determine if the stock is on sale, or at least not overpriced. In order to to do this you must act first and act fast. If your too late price will have already gone up
Liquidity Ratios
- the companys ability to meet day to day operating expenses and satisfiy short term obligations as they become due
Leverage Ratios
- amount of debt used by the company
Profability Ratios
- measures how successful the company is at creating profits
Common Stock Ratios
- converts key financial information per share basis to simplify financail analysis
Current Ratio
- How a company pays their bills, how many dollars of short term assets are availible for every dollar of short term liabilities owed - Higher ratio- more liquidity
Net Working Capital
how many dollars of working capital are availible to pay bills and grow the business - higher amts- firm makes large investments in working capital - lower- firm operates with less working capital
Accounts Recievable Turnover
- how quickly the company is collecting its accounts recieveable (sales to customer on credit) - higher ratio: better
Inventory Turnover
- how quickly the company is selling its inventory - higher ratio: better
Total Asset Turnover
- how efficiently the company is using its assets to support sales - higher ratio: better
Debt-Equity Ratio
- how much debt the company is using to support its business compared to how much stockholders equity it is using to support its business - higher ratio: more risk - lower ratio: less risk
Net Profit Margin-
- amount of profit earned from sales and other operations, can be calculated using net loss as well - higher ratio: better
Return on Assets
- the amount of profit earned on each dollar invested in assets; measures managements efficiency at using assets - higher ratio: better
Return on Equity
= amount of profit earned on each dollar invested by stockholders; measures managments efficiency at using stockholders funds, what kind of return are stockholders getting? - used to decide whether or not this is a healthy company: whether to buy it or sell it - higher ratio: better
Intangeible asset Impairment
- measures a company’s goodwill (accountants decide what is goodwill), treated like a loss but its not a cash outflow. Money gets added back in due to the fact that it is not an actual cash flow - an artificial loss, makes company in better shape than balance sheet states
Price/Earning Ratio
- shows how the stock market is pricing a company’s common stock; least value of all ratios - one of the most widely used ratios in common stock selection - often used in stock valuation models
EPS
- net profits after taxes
Price/Earning Growth Ratio (PEG)
- compares company’s P/E ratio to the rate of growth in earnings; attractive way to view stocks - Ratio>1- stock may be fully valued - PEG=1- sock price in line with earnings growth - Ratio<1- stock may be undervalued
Book Value Per Share
- the difference between assets and liabilities (equity) per share - a company should be worth more than its book value, worth multiple times its book value
Price to book value
compares stock price to book value to see how aggressively the stock is being priced - higher ratio: stock is fully priced or overpriced - lower ratio: stock may be fairly priced or underpriced
Price to Sales
p/s 1 2: stock may be overvalued
Intrinsic Value
- what stock ought to be worth
Interpreting Financial Ratios
- give a look at historical trends, show if a company is favorable or not - ratios allow for comparisons to other companies in a certain industry (trouble with this is that its rare that one firm is only one part of the industry : WalMart
Indications of when a company might be heading towards trouble
- inventories and recievables are growing faster than sales - a falling current ratio, caused by current liabilities increasing faster than current assets (trouble paying bills - high and rapidly increasing debt-to-equity ratio - cash flow from operations dropping below net income or a company using up its cash “you can only bleed for so long” example Kodak
