Kapoor 8ce PPT Ch11

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Chapter 11:

Investing in
Stocks

Ted Stephenson, MBA, CFA, CFP


George Brown College

 2021 McGraw-Hill Education Limited


Chapter 11: Learning Outcomes
(LOs)
LO1 Identify the most important features of
common stocks.
LO2 Discuss the most important features of
preferred stocks.
LO3 Explain how to evaluate stock investments.
LO4 Describe how stocks are bought and sold.
LO5 Explain the trading techniques used by long-
term investors and short-term speculators. 2
 2021 McGraw-Hill Education Limited
Investing in Common Stocks (1)
Identify the Most Important Features of Common
Stocks

What are Stock Markets?


Index: a statistical measure of the changes in a portfolio of
stocks representing a portion of the overall market.
 S&P/TSX Composite Index
 Dow Jones Industrial Average
 NYSE Composite Index
 Nasdaq Composite Index
 Standard & Poor’s 500 Stock Index
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Investing in Common Stocks (2)

Index Characteristics S&P/TSX Composite


Number of Constituents         231
Adjusted Market Capitalization (C$ billion)  2,487.10

Constituent Market Capitalization (Adjusted C$ billion):


Average        10.76 
Largest     142.81
Smallest         0.40
Median         3.24
% Weight Largest Constituent     6.3%
Top 10 Holdings (Market Cap Share; C$Billion)     932.66
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Investing in Common Stocks (3)

Sector Breakdown S&P/TSX Composite


Financials     32.3%
Energy     15.9%
Industrials    11.3%
Materials     10.8%
Information Technology     6.3%
Communication Services     5.5%
Utilities      5.2%
Consumer Staples     4.0%
Consumer Discretionary     3.9%

Real Estate     3.7% 5


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Investing in Common Stocks (4)

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Investing in Common Stocks (5)
Corporations and Common Stock
Public Corporations – stocked trades openly in stock
markets and may be purchased by individuals
Private Corporations – stocks are owned by relatively

few people & are not traded openly in stock markets


1. To finance business start up costs and help pay for
ongoing business activities
2. A form of equity
• They don’t have to repay the money.
• Price is determined by how much buyer willing to pay
3. Dividends are not mandatory
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Investing in Common Stocks (6)
Corporations and Common Stock
4. Stockholders have voting rights and control of the
company
 Proxy – a legal form that lists the issues to be decided at a
shareholder’s meeting and requests the shareholders to
transfer their voting rights to another
 Pre-emptive Right – the right of current shareholders to
purchase any new stock the corporation issues before it is
offered to the general public

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Investing in Common Stocks (7)
Why Investors Purchase Common Stocks
Income from dividends

 Cash, additional stocks or company products


Changes in stock value

 Appreciate in value over time


Possible increased value from stock splits (a procedure
in which the shares of common stocks owned by existing
shareholders are divided into a larger number of shares

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Investing in Common Stocks (8)

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Investing in Common Stocks (9)

Assumptions
100 shares of common stocks purchased Jan 5, 2018, sold Jan 4, 2020; annual
dividends of $1.86 per share for the 2-year period.
Cost When Purchased Proceeds When Sold
100 shares @ $33 =         $3,300 100 shares @ $44 =   $4,400
Plus commission                9 Minus commission       −9
Total cost         $3,309 Net proceeds   $4,391
Transaction Summary
Net proceeds     $     4,391
Minus total cost          −3,309
Profit from stock     $     1,082
sale
Total dividends + 372 ($1.86 per share per year × 100 shares × 2 years) 11
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Preferred Stocks (1)
Discuss the Most Important Features of Preferred Stocks

Investing in Preferred Stocks


Receive cash dividends before common stock holders are paid any

cash dividends
The dividend amount is either a stated amount of money for each

share of preferred stock, or a percentage of the par value


Par value is an assigned dollar value that is printed on a stock

certificate
First claim on corporation’s assets
Callable preferred stock is stock a corporation may exchange for a

specified amount of money


After calling an issue, they can issue new preferred stock with a lower

dividend
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Preferred Stocks (2)
Features of preferred stocks include:
Cumulative feature.

 Unpaid cash dividends accumulate and must be paid


before any cash dividends are paid to the common stock
holders
Participation feature.

 Rare form of investment used to attract investors


 Can share in earnings beyond the stated dividend amount
Conversion feature.

 Can be traded for shares of common stock


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Evaluation of a Stock Issue (1)
Explain How to Evaluate Stock Investments

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 14
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Evaluation of a Stock Issue (2)
 For you the investor, EMH has several implications
including:
 1. Stock prices move randomly and therefore cannot be predicted from past trends in
any consistent manner.
 2. The current market price of a security reflects its “true” value. Therefore, it is
difficult, if not impossible, to consistently find bargains.
 3. Securities are priced and traded on their expected risk–return merits and not on
their unique features. Prices incorporate new information almost instantly and excess
returns are almost impossible to obtain based on historical information.
 4. Market indices (such as the S&P/TSX Composite) and other aggregate market
trends are usually leading indicators of future economic prospects and serve as
benchmarks as to the price behaviour of the average stock.
 5. The relationship between risk and return is positive and the average risk premium
(investment risk minus the risk-free rate of return) is fairly constant over time.
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Evaluation of a Stock Issue (3)
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 16
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Evaluation of a Stock Issue (4)
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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Evaluation of a Stock Issue (5)
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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Evaluation of a Stock Issue (6)

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Evaluation of a Stock Issue (7)

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Evaluation of a Stock Issue (8)

1. Name of the company: Finning International Inc.


2. Lowest price paid for one share of Finning International in the past 52 weeks: $10.60.
3. Highest price paid for one share of Finning International during the past 52 weeks: $25.86.
4. Ticker symbol or letters that identify a stock for trading: FTT
5. Projected annual dividend for next year based on the amount of the firm’s last dividend: ​​
6. Yield percentage, or the percentage of return based on the dividend and previous close price of
the stock: ​​
7. Price–earnings (P/E) ratio—the price of a share of stock divided by the corporation’s earnings
per share of stock outstanding over the last 12 months: ​​
8. Market capitalization of Finning International: $2,554,311,037
9. Highest price paid for one share of Finning International during the current trading day: $16.30
10. Lowest price paid for one share of Finning International during the current trading day:
$14.60
11. Price paid for the last transaction: $15.64

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Evaluation of a Stock Issue (9)

1. Difference between the price paid for the last transaction today and the price paid for the last
share on the previous day: plus $1.30 (in Bay Street terms, Finning International “is up 1.30” on
this day)
2. Ex-dividend date: February 26, 2020
3. Quarterly dividend per share: $0.205
4. Annual earnings per share: $1.48
5. Number of shares outstanding (all classes): 163,319,120
6. 52-week price is trending: downwards
7.Exchange Finnings is traded on: TSX
8.Finnings International Inc. stock beta: 1.3388

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Evaluation of a Stock Issue (10)
Sources of Stock Information:
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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Evaluation of a Stock Issue (11)
Web Site and Description Web Address
Financial Post: Provides news, opinions, market and http://www.financialpost.com
investment information, tools, and much more.

Market Watch: Current price information, news, http://www.marketwatch.com


corporate profile, analyst estimates, and industry
analysis about individual corporate stock issues. Free,
but registration may be required.
TMX: TMX Datalinx provides current, historical, and http://www.tmx.com
index data, along with news, corporate information,
equities, fixed income, and foreign exchange statistics
to help Canadian investors make investment decisions
on the Canadian capital markets.

Standard & Poor’s: Many experienced investors rely http://www.standardandpoors.com


on S&P’s stock reports to provide a snapshot of a
corporation’s activities, performance, and investment
outlook. Individual reports are available for purchase.

Value Line: Detailed research and software that can be http://www.valueline.com


used to sort, screen, graph, and report on individual
common stocks, industry groups, or stock portfolios.
Some information is available for free, but a
subscription is required for more detailed information.
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Evaluation of a Stock Issue (12)

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Evaluation of a Stock Issue (13)

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Evaluation of a Stock Issue (14)

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Evaluation of a Stock Issue (15)
Factors That Influence the Price of a Stock
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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Evaluation of a Stock Issue (16)
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

Annual Shareholder = Annual Dividend + Appreciation in Value


Return Initial Stock Investment

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Evaluation of a Stock Issue (17)
 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

Annual Dividend Yield = Annual Dividend


Initial Stock Investment

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Evaluation of a Stock Issue (18)
 Capital Gains Yield
 A stock’s increase in value divided by its beginning-of-
year stock price

Capital Gains Yield = Appreciation in Value


Initial Stock Investment

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Evaluation of a Stock Issue (19)
 Earnings Per Share
 Are the corporation’s after tax-earnings divided by the
number of outstanding shares of common stock

Earnings Per Share = After-Tax Earnings


Number of outstanding shares
of common stock

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Evaluation of a Stock Issue (20)
 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

Price-Earnings Ratio = Price Per Share


Earnings per share of stock
Outstanding over the last 12 months

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Evaluation of a Stock Issue (21)
 Beta is an index that compares the risk associated
with a specific stock issue with the risk of the stock
market in general.
 Beta < 1 lower than average risk
 Beta = 1 average risk
 Beta > 1 higher than average risk

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Buying and Selling Stocks (1)
Describe How Stocks are Bought and Sold

Primary Markets for Stocks


A market in which an investor purchases financial securities
via an investment bank, or other representative, from the
issuer of those securities
An investment bank is a financial firm that assists
corporations in raising funds usually by helping to sell new
security issues
An Initial Public Offering (IPO) occurs when a corporation
sells stock to the general public for the first time

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Buying and Selling Stocks (2)
Secondary Markets for Stocks
A market for existing financial securities that are
currently traded among investors
 A marketplace where member brokers who represent
investors meet to buy and sell securities
 The securities sold at an exchange must be listed, or
accepted for trading, at the exchange
 Toronto Stock Exchange or Canadian Venture
Exchange

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Buying and Selling Stocks (3)
Secondary Markets for Stocks
The Over-the-Counter (OTC) market.

 Network of dealers who buy and sell the stocks of


companies not listed on a securities exchange;
NASDAQ (an electronic marketplace)

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Buying and Selling Stocks (4)
Brokerage Firms and Account Executives
An account executive, or stockbroker, is a
licensed individual who buys and sells
securities for his or her clients
Churning

 Excessive buying and selling of


securities to generate commissions
Discount broker versus full service brokers

 Cost of research material


 Help in making decisions
 Ease of buying and selling
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Buying and Selling Stocks (5)

Should you Use A Full-Service, Discount, or online


Brokerage Firm?
First, consider how much research information is available and

how much it costs.


Second, consider how much help you need when making an

investment decision.
Third, consider how easy it is to buy and sell stocks and other

securities when using either a full service or discount brokerage


firm.

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Buying and Selling Stocks (6)

Should you Use A Full-Service, Discount, or online Brokerage


Firm?
Questions to ask include:
1. Can I buy or sell stocks over the phone?
2. Can I trade stocks online?
3. Where is your nearest office located?
4. Do you have a toll-free telephone number for customer use?
5. How often do I get statements?
6. Is there a charge for statements, research reports, and other financial reports?
Are there any fees in addition to the commissions I pay when I buy or sell
7.

stocks?
8. Is there a minimum amount of money that I need to invest in the brokerage?
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Buying and Selling Stocks (7)
Should you Use A Full-Service, Discount,
or online Brokerage Firm?
Service Type Investor Type
• Full-service Beginning investors with little or no
experience.
Individuals do not have time to research or
are uncomfortable making investment
decisions.
• Discount People who understand the “how to” of
researching stocks and prefer making their
own decisions.
Individuals who are comfortable trading
stocks online.
• Online People who understand the “how to” of
researching stocks and prefer to make their
own decisions. Individuals who are
comfortable trading stocks online. 41
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Buying and Selling Stocks (8)

Types of Stock Orders


A market order is a request to buy or sell stock at the
current market value
A limit order is a request to buy or sell a stock at a

specified price or price range


A stop order is a request to sell a stock at the next

available opportunity after its market price reaches a


specified amount
A discretionary order lets the account executive

decide when to execute the transaction and at what price


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Buying and Selling Stocks (9)
 Computerized transactions:
 Discount brokerage firms and some full services
brokerage firms allow investors to trade online
 It can make the process cheaper and faster
 Commission charges:
 Wide range depending on the amount of service
 Round lot is 100 shares or multiples of 100 shares An
odd lot is fewer than 100 shares

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Buying and Selling Stocks (10)
Firm Basic Flat Fees* Additional Services
RBC Direct from the $6.95 to $9.95 for all equity trades Education centre, monthly data,
Royal Bank of Canada depending on volume and account statements for tax reporting, links
http://www.rbcdirectinvesting.com balance
Scotia iTrade $4.99 to $9.99 per trade, depending on Margin interest, quarterly statements,
http://www.scotiabank.com/itrade/e volume and account balance analyst reports, tax statements,
n/0,,3692,00.html research
Questrade $4.95 to $9.95 per trade, depending on Market analyses, online service
http://www.questrade.com volume and account balance demonstration, portfolio management
tools
Investorline from the $9.95 for all equity trades Online services demonstration,
Bank of Montreal glossary of products
http://www.bmoinvestorline.com
TD Direct Investing from TD Bank $7.00 to $9.95 per trade, depending on Real-time quotes, research, news,
http://www.tdwaterhouse.ca/produc volume and account balance charts, statistics
ts-services/investing/td-direct-
investing/index.jsp
An independent online brokerage $6.95 to $9.95, depending on volume Online tools and research available, as
http://www.qtrade.ca well as information and tutorials on
many investment options; low
commission rates. 44
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Buying and Selling Stocks (11)
Securities Regulation
To ensure full, true and plain disclosure of all facts by
sellers of securities
Provincial Regulation

 Registration
 Disclosure
 Enforcement
 Self Regulatory Organizations
 Are responsible for industry conformity with securities
legislation

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Long-Term and Short-Term Investment
Strategies (1)
Explain the Trading Techniques Used by Long-term
Investors and Short-term Speculators

Long-Term Techniques
Diversification
 Involves combining many assets in a portfolio to reduce the
risk
Buy and Hold Technique
 Portfolio value increases through dividend payment,
appreciation in stock value and dividend reinvestment
Dollar Cost Averaging
 Investors purchase an equal dollar amount of the same
stocks at equal intervals
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Long-Term and Short-Term Investment
Strategies (2)
Long-Term Techniques
 Direct Investment and Dividend Reinvestment Plans
 Purchase stocks directly from the corporation
 Reinvest dividends to purchase more stocks
Private Equity

 An asset class consisting of equity securities that are


not publically traded

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Long-Term and Short-Term Investment
Strategies (3)
Short-Term Techniques
Hedge Funds

 An investment fund that serves a group of investors

Buying stock on margin

 borrowing money to buy a particular stock

Selling short

 borrowing stock that must be replaced later

Trading in options

 The right to buy or sell stocks at a predetermined price


during a specified period of time 48
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Long-Term and Short-Term Investment
Strategies (4)

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Long-Term and Short-Term Investment
Strategies (5)

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Long-Term and Short-Term Investment
Strategies (6)

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Summary (1)
LO1 Identify the most important features of
common stocks
 Corporations sell stocks to
 Finance their start up costs
 Help pay for ongoing business activities
 People invest because of
 Dividend income, appreciation of value, and gain
through stock splits
 Dividend payments must be approved by the Board of
Directors

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Summary (2)
LO1 Identify the most important features of
common stocks
 Shareholders have right to elect Board and approve
changes to corporate policy that include
 Amendment to corporate charter
 Sale of certain assets
 Possible mergers
 Issuance of preferred stocks or corporate bonds
 Changes in the amount of common stock

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Summary (3)
LO2 Discuss the most important features of
preferred stock
 Receive dividends before common shareholders
 May include extra features
 Cumulative feature
 Participation feature
 Conversion feature

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Summary (4)
LO3 Explain how you can evaluate stock investments
 Information contained in newspaper or internet
 Be familiar with various measures of corporate and
investment performance
 Typical psychological biases
 Two different analytical techniques used in stock selection
 Theory of efficient markets

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Summary (5)
LO4 Describe how stocks are bought and sold
 New stock issues sold through investment bank or
directly to current shareholders
 In secondary market through a securities exchange or
over-the-counter market
 Most investments done through account executive or
online
 Minimum commission charged for buying or selling stocks
 Additional commission charged based on
 Number and value of shares bought or sold
 Full service or discount broker or online
 Regulations in place to protect investors
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Summary (6)
LO5 Explain the trading techniques used by long-term
investors and short-term speculators
 Long-term
 Hold investments for at least a year
 Build a diversified portfolio
 Buy-and-hold technique
 Dollar cost averaging
 Direct investment plans
 Dividend reinvestment plans

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Summary (7)
 Explain the trading techniques used by long-term
investors and short-term speculators
 Short-term
 Sell investments within short period of time
 Buy on margin
 Sell short
 Trade in options

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