LN06 Smart3075419 12 FI C06

Chapter 6
Common Stocks
Common Stocks
Learning Goals
1. Explain the investment appeal of common
stocks and why individuals like to invest in
them.
2. Describe stock returns from a historical
perspective and understand how current returns
measure up to historical standards of
performance.
3. Discuss the basic features of common stocks,
including issue characteristics, stock quotations,
and transaction costs.
Copyright 2014 Pearson Education, Inc. All rights reserved.
6-2
Common Stocks
Learning Goals (contd)
4. Understand the different kinds of common stock
values.
5. Discuss common stock dividends, types of
dividends, and dividend reinvestment plans.
6. Describe various types of common stocks,
including foreign stocks, and note how stocks
can be used as investments.
6-3
The Appeal of Common Stocks

Residual Owners: stockholders of a firm are the
owners, who are entitled to dividend income and a
prorated share of the firms earnings only after all
the firms other obligations have been met
Stocks allow investors to tailor investments to meet
individual needs and preferences
Stocks may provide a steady stream of current income
through dividends
Stocks may increase in value over time through
capital gains
6-4
Table 6.1 Historical Returns on the

Standard and Poors 500, 1950-2010
6-5
Figure 6.1 A Snapshot of U.S. Stock Prices and

Housing Indexes (mid-2003 through mid-2012)
(Source: Data from Yahoo! Finance and Standard & Poors.)

6-6
From Stock Prices to Stock Returns

Stock Returns: take into account both
price changes and dividend income
Returns from capital gains range from an
average of 15.3% during the 1990s to -2.7%
from 20002010
Returns from dividends vary too, but not nearly
as much, ranging from 5.4% in the 1950s to
1.8% since 2000
The big returns (or losses) come from capital
gains
6-7
From Stock Prices to Stock Returns

(contd)
Stocks generally earn positive returns over long periods of
time.
From 19502000, the average total return on the S&P 500
was 11% per year
Investing in stocks is clearly not without risk
From 20002010, the U.S. stock market lost 1% per year
6-8
What is a Bear Market?

Routine Decline: a drop of 5% or more in
one of the major market indexes, like the
Dow Jones Industrial Average (DJIA)
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
6-9
Advantages of Stock Ownership

Provide opportunity for higher returns than other
investments
Over past 100 years, stocks earned annual returns
that we roughly double the returns provided by
corporate bonds
Good inflation hedge since returns typically exceed
the rate of inflation
Easy to buy and sell stocks
Price and market information is easy to find in
financial media
Unit cost per share of stock is low enough to
encourage ownership
6-10
Disadvantages of Stock Ownership

Stocks are subject to many different kinds of risk:
Business risk
Financial risk
Purchasing power risk
Market risk
Event risk
Hard to predict which stocks will go up in value due

to wide swings in profits and general stock market
performance
Low current income compared to other
investment alternatives
6-11
Figure 6.2 The Current Income of

Stocks and Bonds
(Source: Data from Federal Reserve Board of Governors and

www.multpl.com/s-p-500-dividend-yield/table.)
6-12
Basic Characteristics of Common

Stock
Equity Capital: evidence of ownership position in
a firm, in the form of shares of common stock.
This is why stocks are sometimes called equities
Publicly Traded Issues: shares of stock that are
readily available to the general market and are
bought and sold in the open market
Public Offering: an offering to sell to the
investing public a set number of shares of a firms
stock at a specified price
6-13

Stock (contd)
Rights Offering: an offering of a new issue of
stock to existing stockholders, who may purchase
new shares in proportion to their current ownership
Stock Spin-Off: conversion of one of a firms
subsidiaries to a stand-alone company by
distribution of stock in the new company to existing
shareholders
6-14

Stock (contd)
Stock Split: when a company increases the
number of shares outstanding by
exchanging a specified number of new
shares of stock for each outstanding share
Usually done to lower the stock price to make it
more attractive to investors
Stockholders end up with more shares of stock
that sells for a lower price
Investor with 200 shares in a 2-for-1 stock split
would have 400 shares after the stock split
If the stock price was $100 before the split, the
price would be near $50 after the split
6-15

Stock (contd)
Treasury Stock: shares of stock that were
originally sold by the company and have been
repurchased by the company. Share repurchases
are often called buybacks.
Reduces the number of shares outstanding to public
Companies buyback when they believe stock is
undervalued and a good buy
Companies may try to raise undervalued stock price or
prop up overvalued stock price
May be used for mergers, acquisitions or employee stock
option plans
6-16

Stock (contd)
Classified Common Stock: common stock issued
in different classes, each of which offers different
privileges and benefits to its holders
Different shares may have different voting rights
Often used to allow a relatively small group to control the
voting of a publicly-trade company
Ford family owns B shares and other investors own A
shares; Ford family controls 40% of Ford Motor Company
May have different dividend payout schedules
6-17
Figure 6.4 A Stock Quote for

Abercrombie & Fitch
(Source: Yahoo! Finance, http://finance.yahoo.com/q?s=ANF&ql=0.)

6-18
Watch Those Transaction Costs

Round-Lot: buying 100 shares of stock or
multiples of 100 shares
Odd-Lot: buying less than 100 shares of
stock
Buying odd lots or small numbers of shares can
result in higher costs to buy and sell shares
Frequent trading can increase transactions
costs substantially
6-19
Common Stock Values

Par Value: the stated, or face, value of a stock
Mainly an accounting term and not very useful to
investors
Book Value: the amount of stockholders equity
The difference between the companys assets minus the

companys liabilities and preferred stock
Market Value: the current price of the stock in

the stock market
6-20
Common Stock Values

Market Capitalization: the overall current value
of the company in the stock market
Total number of shares outstanding multiplied by the
market value per share
Investment Value: the amount that investors

believe the stock should be trading for, or what
they think its worth
Probably the most important measure for a stockholder
6-21
Dividends
Dividend income is one of the two basic sources of return to
investors
Dividend income is more predictable than capital gains, so
preferred by investors seeking lower risk
Through 2012, dividends were taxed at maximum 15% tax
rate, same as capital gains
Since 2013, dividend tax rate is as high as 20% for high
earners (not counting a 3.8% Medicare tax on investment
income that high earners must also pay)
Dividends tend to increase over time as companies earnings
grow; average annual increase around 3% to 5%
Dividends represent the return of part of the profit of the
company to the owners, the stockholders
6-22
Key Dates for Dividends
6-23
Dividends and Earnings Per Share

Earnings Per Share: the amount of
annual earnings available to common
stockholders, stated on a per-share basis
Earnings are important to stock price
Earnings help determine dividend payouts
6-24
Dividends and Dividend Yield

Dividend Yield: a measure to relate dividends to
share price on a percentage basis
Indicates the rate of current income earned on the
investment dollar
Convenient method to compare income return to other
investment alternatives
6-25
Dividends and Dividend Payout Ratio

Dividend Payout Ratio: the portion of
earnings per share (EPS) that a firm pays
out as dividends
Companies are not required to pay dividends

Some companies have high EPS, but reinvest all
money back into company
6-26
Other Dividend Characteristics

Stock Dividend: payment of a dividend in the
form of additional shares of stock
Dividend Reinvestment Plans (DRIPs): plans
where cash dividends are automatically reinvested
into additional shares of the firms common stock
Over 1,000 companies offer DRIPs
Usually have no brokerage fees
Uses dollar-cost averaging
6-27
Types of Stock
Blue Chip Stocks: financially strong, highquality stocks with long and stable records
of earnings and dividends
Companies are leaders in their industries
Relatively lower risk due to financial stability
of company
Popular with investing public looking for steady
growth potential, perhaps dividend income
Provide shelter during unsettled markets
Examples: AT&T, Chevron, Johnson & Johnson,
McDonalds, Pfizer
6-28
Figure 6.5 A
Blue-Chip Stock
(Source: Copyright 2012 Zacks

Investment Research. All rights
reserved. www.zacks.com, July
10, 2012.)
6-29
Types of Stock (contd)

Income Stocks: stocks with long and sustained
records of paying higher-than average dividends
Good for investors looking for relatively safe and high
level of current income
Dividends tend to increase over time (unlike interest
payments on bonds)
Some companies pay high dividends because they offer
limited growth potential
More subject to interest rate risk
Examples: Duke Energy, Conagra Foods, General Mills,
Altria Group
6-30

Growth Stocks: stocks that experience high rates
of growth in operations and earnings
Have sustained rate of growth in earnings above general
market
Investors expect higher price appreciation due to
increasing earnings
Riskier investment because price may fall if earnings
growth cannot be maintained
May include blue chip stocks as well as
speculative stocks
Typically pay little or no dividends
Examples: Amazon, Apple, Google, eBay, Berkshire
Hathaway, Starbucks
6-31

Tech Stocks: stocks representing the technology
sector of the market
Range from speculative stocks of small companies that
have never shown a profit to blue chip stocks of large
companies that are growth-oriented
Potential for attractive returns
Considerable risk and volatility
Difficult to put value on due to erratic or no earnings
Examples: Microsoft, Cisco Systems, Yahoo!, NVIDIA,
SanDisk, Intel, Electronic Arts
6-32
Figure 6.6
A Tech Stock
(Source: Copyright 2012 Zacks

Investment Research. All rights
reserved. www.zacks.com, July
10, 2012.)
6-33

Speculative Stocks: stocks that offer potential for
substantial price appreciation, usually due to some
special situation such as a new product
Companies lack sustained track record of business and
financial success
Earnings may be uncertain or highly unstable
Potential for substantial price appreciation
Stock price subject to wide swings up and down in value
Examples: Sirius XM Radio, Dreamworks Animation,
Liberty Media, Under Armour
6-34

Cyclical Stocks: stocks whose earnings
and overall market performance are closely
linked to the general state of the economy
Stock price tends to move up and down with the
business cycle
Tend to do well when economy is growing,
especially in early stages of economic recovery
Tend to do poorly in slowing economy
Best for investors willing to move in and out of
market as economy changes
Examples: Alcoa, Caterpillar, Genuine Parts,
Lennar, Brunswick, Timken
6-35

Defensive Stocks: stocks that tend to hold their
value, and even do well, when the economy starts
to falter
Stock price remains stable or increases when general
economy is slowing
Products are staples that people use in good times and
bad times, such as electricity, beverages, foods and drugs
Gold stocks are a form of defensive stock
Best for aggressive investors looking for parking place
during slow economy
Examples: Walmart, Checkpoint Systems, WD-40
6-36
Market Capitalization
U.S. stock market segments based on stock
market capitalization:
Small-Cap Stocks: less than $2 billion
Mid-Cap Stocks: $2 billion to $10 billion
Large-Cap Stocks: more than $10 billion
6-37

Large-Cap Stocks: large companies with market
capitalizations over $10 billion
Number of companies is smaller, but account for 80% to
90% of the total market value of all U.S. equities
Bigger is not necessarily better
Tend to lag behind small-cap and mid-cap stocks, but
typically have less volatility
Examples: Walmart, Exxon Mobil, Apple
6-38

Mid-Cap Stocks: medium-sized companies with
market capitalizations between $2 billion and $10
billion
Provide opportunity for greater capital appreciation than
Large-Cap stocks, but less price volatility than Small-Cap
stocks
Usually have long-term track records for profits and stock
valuation
Baby Blues offer same characteristics of Blue Chip
stocks except size
Examples: Logitech, American Eagle Outfitters, Garmin
Ltd.
6-39

Small-Cap Stocks: small companies with
market capitalizations less than $2 billion
Provide opportunity for above-average returns
(or losses)
Usually do not have a financial track record
Earnings tend to grow in spurts and can have
dramatic impact on stock price
Usually not widely-traded; liquidity is an issue
Initial Public Offerings (IPOs)
Examples: Callaway Golf, Wendys, Shoe
Carnival
6-40
Investing in Foreign Stocks

Globalization of financial markets is growing
U.S. equity market represents roughly 35% of world
equity markets
Six countries make up 80% of world equity market
U.S. market remains largest equity market in world with a
total value of about $16 trillion in 2012
Some of the returns in non-U.S. markets are due to
currency exchange rates, and not just markets themselves
6-41
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
Buying American Depositary Shares (ADSs)
Simpler approach
Bought and sold on U.S. markets just like stocks
in
U.S. companies
Transactions are in U.S. dollars
Buying International Mutual Funds

6-42
Going Global
International investing is more complex and
riskier than domestic investing
International investing requires investors to
be right on more factors:
Must pick right stock
Must pick right market
Must pick correct direction for currency
exchange rate fluctuations
6-43
Returns on International
Investments
Stronger U.S. dollar has negative impact on
foreign investments
Weaker U.S. dollar has positive impact on
foreign investments
6-44
Alternative Investment
Strategies
Storehouse of Value
Safety of investment is primary goal
Investors use high-quality blue chip and non-speculative
stocks
To Accumulate Capital
Growth of investment is primary goal
Investors use growth-oriented stocks to generate capital
gains
Source of Income
Current income is primary goal
Investors use stocks with dependable flow of dividends
6-45
Stock Investment Strategies

Buy-and-Hold
Investors buy high-quality stocks and hold them for
extended time periods
Goal may be current income and/or capital gains
Investors often add to existing stocks over time
Very conservative approach; value-oriented
6-46
Stock Investment Strategies (contd)

Current Income
Investors buy stocks that have high dividend
yields
Safety of principal and stability of income are
primary goals
May be preferable to bonds because dividends
levels tend to increase over time
Often used to provide to supplement other
income, such as in retirement
6-47

Quality Long-Term Growth
Investors buy high-quality growth stocks, mid-cap stocks
and tech stocks
Capital gains are primary goal
Higher level of risk due to emphasis on capital gains
Significant trading of stocks may occur over time
Diversification is used to spread risk
Total Return Approach is version that emphasizes both
capital gains and high income
6-48

Aggressive Stock Management
Investors buy high-quality growth stocks, blue chip
stocks, mid-cap stocks, tech stocks and cyclical stocks
High level of risk due to emphasis on capital gains
Investors aggressively trade in and out of stocks, often
holding for short periods
Timing the market is key element
Time consuming to manage
6-49

Speculation and Short-Term Trading
Also called day trading
Investors buy speculative stocks, small-cap
stocks and tech stocks
Highest level of risk due to emphasis on capital
gains in short time period
Investors aggressively trade in and out of
stocks, often holding for extremely short periods
Looking for big score on unknown stock
Time consuming & high trading costs
6-50
Chapter 6 Review
Learning Goals
1. Explain the investment appeal of common
stocks and why individuals like to invest in
them.
2. Describe stock returns from a historical
perspective and understand how current returns
measure up to historical standards of
performance.
3. Discuss the basic features of common stocks,
including issue characteristics, stock quotations,
and transaction costs.
6-51
Chapter 6 Review (contd)

Learning Goals (contd)
4. Understand the different kinds of common stock
values.
5. Discuss common stock dividends, types of
dividends, and dividend reinvestment plans.
6. Describe various types of common stocks,
including foreign stocks, and note how stocks
can be used as investment.
6-52
Chapter 6
Additional
Chapter Art
Figure 6.3 An
Announcement of
a New Stock Issue
6-54
Table 6.2 Cash or Reinvested

Dividends?
6-55
Figure 6.7 Average Annual Stock Returns

Around the World (1900 to 2011)
(Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Credit Suisse Global Investment Returns Sourcebook 2012,
https://www.creditsuisse.com/investment_banking/doc/cs_global_investment_returns_yearbook.pdf.)
6-56

LN06 Smart3075419 12 FI C06

Încărcat de

Informații document

Titlu original

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

LN06 Smart3075419 12 FI C06

Încărcat de

Drepturi de autor:

Formate disponibile

Chapter 6

Copyright 2014 Pearson Education, Inc. All rights reserved.

The Appeal of Common Stocks

Copyright 2014 Pearson Education, Inc. All rights reserved.

Table 6.1 Historical Returns on the

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 6.1 A Snapshot of U.S. Stock Prices and

(Source: Data from Yahoo! Finance and Standard & Poors.)

From Stock Prices to Stock Returns

From Stock Prices to Stock Returns

Copyright 2014 Pearson Education, Inc. All rights reserved.

What is a Bear Market?

Copyright 2014 Pearson Education, Inc. All rights reserved.

Advantages of Stock Ownership

Disadvantages of Stock Ownership

Hard to predict which stocks will go up in value due

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 6.2 The Current Income of

(Source: Data from Federal Reserve Board of Governors and

Basic Characteristics of Common

Copyright 2014 Pearson Education, Inc. All rights reserved.

Basic Characteristics of Common

Copyright 2014 Pearson Education, Inc. All rights reserved.

Basic Characteristics of Common

Copyright 2014 Pearson Education, Inc. All rights reserved.

Basic Characteristics of Common

Copyright 2014 Pearson Education, Inc. All rights reserved.

Basic Characteristics of Common

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 6.4 A Stock Quote for

(Source: Yahoo! Finance, http://finance.yahoo.com/q?s=ANF&ql=0.)

Watch Those Transaction Costs

Copyright 2014 Pearson Education, Inc. All rights reserved.

Common Stock Values

Book Value: the amount of stockholders equity

The difference between the companys assets minus the

Market Value: the current price of the stock in

Copyright 2014 Pearson Education, Inc. All rights reserved.

Common Stock Values

Investment Value: the amount that investors

Probably the most important measure for a stockholder

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Key Dates for Dividends

Copyright 2014 Pearson Education, Inc. All rights reserved.

Dividends and Earnings Per Share

Copyright 2014 Pearson Education, Inc. All rights reserved.

Dividends and Dividend Yield

Copyright 2014 Pearson Education, Inc. All rights reserved.

Dividends and Dividend Payout Ratio

Companies are not required to pay dividends

Copyright 2014 Pearson Education, Inc. All rights reserved.

Other Dividend Characteristics

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

(Source: Copyright 2012 Zacks

Types of Stock (contd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Types of Stock (contd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

Types of Stock (contd)

Copyright 2014 Pearson Education, Inc. All rights reserved.

(Source: Copyright 2012 Zacks