CH-14 Investing in Stocks – Personal Finance : Chapter Notes

14 INVESTING IN STOCKS CHAPTER OVERVIEW Initially, this chapter describes both common and preferred stock as investment alternatives. We discuss the topics of why corporations sell common stocks and why investors purchase those stocks. Next, we examine the major differences between common stock and preferred stock. Methods that investors can use to evaluate stock investments are presented. Then the steps involved in buying and selling stocks are described. We also explain the long-term techniques of buy and hold, dollar cost averaging, direct investment plans, and dividend reinvestment plans. Finally, the speculative techniques of day trading, margin transactions, selling short, and stock options are also discussed. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO 14-1 Identify the most important features of common and preferred stock. Both common and preferred stock are equity financing. Corporations sell common stock to finance their business start-up costs and help pay for their business expansion and their ongoing business activities. People invest in common stock because of dividend income and appreciation of value. There is also the possibility of gain through stock splits. Dividend payments must be approved by a corporation’s board of directors. In return for providing the money needed to finance the corporation, stockholders have the right to elect the board of directors. They must also approve changes to the corporate policies. The most important priority that an investor in preferred stock enjoys is receiving cash dividends before any cash dividends are paid to common stockholders. Still, dividend distributions to both preferred and common stockholders must be approved by the board of directors. LO 14-2 Explain how you can evaluate stock investments. A number of factors can make a share of stock increase or decrease in value. Depending on specific characteristics associated with a stock investment, account executives, financial planners, and investors often classify a particular stock investment as blue chip, cyclical, defensive, growth, income, large cap, micro cap, mid cap, penny stock, or small cap. When evaluating a particular stock issue, most investors begin with the information contained on the Internet. Stock advisory services, annual reports, information contained on the SEC web site, and in newspapers and business periodicals, can all be used to evaluate potential stock investments. 14-1 LEARNING OBJECTIVES CHAPTER SUMMARY LO 14-3 Analyze the numerical measures that cause a stock to increase or decrease in value. Many analysts believe that a corporation’s ability or inability to generate earnings in the future may be one of the most significant factors that account for an increase or decrease in the value of a stock. Generally higher earnings equate to higher stock value, and lower earnings equate to lower stock value. It is also possible to calculate earnings per share and a price-earnings ratio to evaluate a stock investment. While both earnings per share and a price- earnings ratio are historical numbers based on what a corporation has already done, it is possible to obtain earnings estimates for most corporations. Other calculations that help evaluate stock investments include dividend payout, dividend yield, total return, annualized holding period yield, beta, book value, and market-to- book ratio. Fundamental analysis, technical analysis, and the efficient market theory can also be used to explain the price movements that occur in the stock market. LO 14- 4 Describe how stocks are bought and sold. A corporation may sell a new stock issue in the primary market with the help of an investment bank. Once the stock has been sold in the primary market, it can be sold time and again in the secondary market. In the secondary market, investors buy and sell stock listed on a securities exchange or traded in the over-the- counter market. Most securities transactions are made through an account executive who works for a brokerage firm. A growing number of investors are using discount brokerage firms or online firms to complete security transactions. Most brokerage firms charge a minimum commission for buying or selling stock. Additional commission charges are generally based on the number and value of the stock shares that are bought and sold and if you use a full-service or discount broker or trade stocks online. To purchase stocks you can use a market, limit, or stop-loss order. LO 14-5 Explain the trading techniques used by long-term investors and short-term speculators. Purchased stock may be classified as either a long-term investment or a speculative investment. Long-term investors typically hold their investments for at least a year or longer; speculators (sometimes referred to as traders) usually sell their investments within a shorter period of time. Traditional trading techniques used by long-term investors include the buy and hold technique, dollar cost averaging, direct investment plans, and dividend reinvestment plans. More speculative techniques include day trading, buying on margin, selling short, and trading in options. 14-2 INTRODUCTORY ACTIVITIES • Ask students to comment on the questions in the My Life feature: Why Stocks? (p. 481). • Point out the learning objectives (p. 481) in an effort to highlight the key points in the chapter. • Ask students to share various attitudes toward investing in stock. • Discuss factors that would make certain stocks an attractive investment. WHAT’S NEW Selected Topics Benefits for the Teaching and Learning Environment New content: Why people invest in stocks New content: How to make a decision to buy or sell stocks Updated information: Income from dividends Updated Exhibit 14-2 Sample stock transaction New Exhibit 14-5: Stock information from the Internet Updated Did You Know New Exhibit 14-7: Value Line research information New coverage: Stock market bubbles Updated coverage: Numerical measures New box feature: Financial Planning Calculations Updated boxed feature: Explains the psychological reasons why people choose stocks for a long-term investment program. Provides some specific steps to help individuals make a decision to buy or sell a stock. Explains the importance of the record date for a quarterly dividend distribution for Chevron. Illustrates how investors can make money with a stock investment in the Walt Disney Corporation. Describes the type of information provided by the Yahoo! Finance website for the Gap Corporation. Provides new information about historical values for the Dow Jones Industrial Average for the period December 2007 through December 2012. Illustrates the type of detailed research information for Dollar Tree, Inc. available from the Value Line professional advisory service Defines a stock market bubble and describes how it can affect the value of an investment. Provides updated examples for all examples in the section “Numerical Measures that Influence Investment Decisions. Illustrates how the time value of money can affect the value of a stock investment. Includes current statistics for the Boeing Company that are 14-3 Financial Planning Calculations Updated Exhibit 14-8: Typical commission charges New information: Limit orders New Did You Know Revised Exhibit 14-9: Dollar-cost averaging New example: Margin transactions New material: Selling short New Dashboard feature New Time Value of Money Problems New Financial Planning Case used to illustrate the Price/Earnings to Growth (PEG) ratio calculation. Shows current commission charges for some popular online brokerage firms. Illustrates how a limit order can be used to specify a price to buy or sell stock in Macy’s. Gives an explanation of how Wall Street got its name. Includes seven years of investments instead of four years for the dollar-cost averaging example. Provides an example of how investors can increase their profits by using margin. Provides new material and an example on the selling short process that investors can use to increase profits. Points out why investors need to save money before they begin investing. Adds new problems that illustrate how the time value of money can affect investment returns and cumulative dividend amounts. Allows students a chance to increase their ability to research a stock investment in Dollar Tree, Inc. and is based on the Value Line research information contained in Exhibit 14-7. CHAPTER 14 OUTLINE I. Common and Preferred Stock A. Why Corporations Issue Common Stock 1. A Form of Equity 2. Dividends Not Mandatory 3. Voting Rights and Control of the Company B. Why Investors Purchase Common Stock 1. The Psychology of Stock Investing 2. Income from Dividends 3. Dollar Appreciation of Stock Value 3. What Happens When a Corporation Splits Its Stock? 14-4 C. Preferred Stock II. Evaluating a Stock Issue A. Classification of Stock Investments B. The Internet C. Stock Advisory Services D. Newspaper Coverage and Corporate News III. Numerical Measures that Influence Investment Decisions A. Why Corporate Earnings Are Important B. Projected Earnings C. Other Factors that Influence the Price of a Stock D. Investment Theories IV. Buying and Selling Stocks A. Secondary Markets for Stocks 1. Securities Exchanges 2. The Over-the-Counter Market B. Brokerage Firms and Account Executives C. Should You Use a Full-Service, Discount, or Online Brokerage Firm? D. Commission Charges E. Completing Stock Transactions VI. Long-Term and Short-Term Investment Strategies A. Long-Term Techniques 1. Buy and Hold Technique 2. Dollar Cost Averaging 3. Direct Investment and Dividend Reinvestment Plans B. Short-Term Techniques 1. Day Trading 2. Buying Stock on Margin 3. Selling Short 4. Trading in Options 14-5 CHAPTER 14 LECTURE OUTLINE I. COMMON AND PREFERRED STOCK (p. 482) • This chapter is all about evaluating stock investments. The overall objective is to learn how to evaluate a stock and to make money from your investment decisions. • Today a lot of people buy and sell stocks. Why? The most obvious answer is simple: they want larger returns than more conservative investments offer. Why Corporations Issue Common Stock (p. 482) • Common stock is the most basic form of ownership for a corporation. • Corporations sell common stock to finance their business start-up costs and help pay for expansion and their ongoing business activities. • Corporate managers prefer selling common stock for a number of reasons. 1. It is a form of equity and does not have to be repaid. Equity financing is money received from the sale of shares of ownership in a business. 2. A dividend is a distribution of money, stock, or other property that a corporation pays to stockholders. Dividends must be approved by the board of directors and are not mandatory. • In return for the financing, management must make concessions to stockholders that may restrict corporate policy. 1. Common stockholders elect the board of directors and approve major changes in corporate policies. 2. Stockholders vote in person or by proxy at the corporation’s annual meeting. A proxy is a legal form that lists the issues to be decided at a stockholders’ meeting and requests that stockholders transfer their voting rights to some individual or individuals. Why Investors Purchase Common Stock (p. 483) • The Psychology of Stock Investing (p. 483) • Why do people invest in stocks? The simple answer is that investors want the larger returns that stocks offer, even though they are aware of the potential for losses. • Since 1926, stocks, as measured by the Standard and Poor 500 Stock Index have averaged an annual return of 9.8 percent. • Since 1926, stocks had positive gains in 63 years. Instructional Suggestions • Use PPT slides 14-1, 14-2, and 14-3. • Discussion Question: How many of you own stock in a corporation? Why did you invest in common stock? • Use PPT slide 14-4. • Discussion Question: Why do corporations issue common stock? • Use PPT slide 14-5. • Discussion Question: What types of issues do stockholders vote on? • Discussion Question: How do most stockholders exercise their right to vote at a corporation’s annual meeting? • Use PPT slide 14-6. • Text Highlight: You may want to discuss the example of how one investor made money by investing in McDonald’s—see page 483. • Text Highlight: Use the Did You Know feature on page 484 to illustrate the percentage of people in different age groups that own stocks. • Boxed Feature: The How To . . . Open an Account with a Brokerage Firm feature on page 486 provides 5 suggestions that students can use to open an investment account. 14-6 CHAPTER 14 LECTURE OUTLINE • Since 1926, stocks lost money in 25 years. • While the first two statistics are pretty impressive, investors sometimes forget that stocks can decrease in value. • The key to success with any investment program is often the opportunity to allow your investments to work for you over a long period of time. • That’s why it is so important for people in their twenties and thirties to begin an investment program. The sooner you start investing, the more time your investments have to work for you. • The following suggestions can be used to reduce anxiety when you make stock investment decisions. 1. Evaluate each investment. 2. Analyze the firm’s finances. 3. Track the firm’s product line. 4. Monitor economic developments. 5. Be patient. • How do you make money by buying stock? Basically there are two ways that an investment in common stock can increase in value. • Income from dividends 1. The record date is the date on which a stockholder must be registered on the corporation’s books in order to receive dividend payments. 2. The term ex-dividend describes a situation when a stock trades “without dividend” and the seller—not the buyer—is entitled to a declared dividend payment— see Exhibit 14-1. • Dollar appreciation of stock value. A sample stock transaction for Walt Disney is presented in Exhibit 14-2. The investor received both dividends and profit when the stock was sold. What Happens When a Corporation Splits Its Stocks? (p. 487) • A stock split is a procedure in which the shares of stock owned by existing stockholders are divided into a larger number of shares. 1. Why do corporations split their stock? In many cases, a firm’s management has a theoretical ideal price range for the firm’s stock. A stock split can bring the market value back into that theoretical range. 2. The lower market value for each share of stock is the result of dividing the dollar value of the company by a larger number of shares of common stock. Instructional Suggestions • Text Highlight: You may want to review the information about dividends and the ex-dividend date presented on page 485 in Exhibit 14-1 with students. • Current Example: You may want to review the stock transaction illustrated in Exhibit 14-2 with students—see page 487. • Discussion Point: Have students examine Exhibit 14-3 on how a stock split affects a corporation’s capitalization and stock value before and after a stock split. 14-7 CHAPTER 14 LECTURE OUTLINE • This attraction is based on the belief that most corporations split their stock only when their financial future is improving are on the upswing. • Be Warned: There are no guarantees that a stock’s market value will go up after a stock split. • The effects of a 2-for-1stock split on the common stock split issued by Martin & Martin, Inc. are illustrated in Exhibit 14-3. PREFERRED STOCK (p. 488) • In addition to, or instead of, purchasing common stock, you may purchase preferred stock. • Preferred stock is a type of stock that gives the owner the advantage of receiving cash dividends before common stockholders are paid any dividends. This is the most important priority that an investor in preferred stock enjoys. • The dividend for preferred stock is known before the stock is purchased. • Preferred stocks are often referred to as a middle investment between common stock (an ownership position) and corporate bonds (a creditor position). • Preferred stock issues are often purchased by individuals who need a predictable source of income greater than offer by common stock investments. • They are also purchased by other corporations, because corporations receive a tax break on the dividend income. • For all other investors, preferred stocks lack the growth potential that common stocks offer and the safety of many corporate bond issues. • While preferred stock does not represent a legal debt that must be repaid, if the firm is dissolved or declares bankruptcy, preferred stockholders do have first claim to the corporation’s assets after creditors (including bondholders). In reality, preferred stockholders don’t receive anything in most bankruptcies. • Preferred stock, like common stock is equity financing that does not have to be repaid. And dividends on preferred stock may be omitted by action of the board of directors. Instructional Suggestions • Text Highlight: You may want to discuss the My Life feature on how people make money with stock investments at this point in your lecture—see page 487. • Use PPT slides 14-7 and 14-8. • Discussion Question: Why would an investor purchase preferred stock? • Practice Quiz 14-1 (p. 488) 14-8 CHAPTER 14 LECTURE OUTLINE II. EVALUATING A STOCK ISSUE (p. 489) • A wealth of information is available to investors in stock, and a logical place to start is with the classification of stock investments. Instructional Suggestions • Use PPT slide 14-9. Classification of Stock Investments (p. 489) • We describe ten classifications for stock investment that are commonly used by investors, financial planners, and stockbrokers. • Choosing different stock classifications may help you use asset allocation to diversify your investments. • Exhibit 14-4 provides information on the major classifications of stock investments. • Text Highlight: Use Exhibit 14-4 to highlight the common stock classifications. • Discussion Question: What factors would lead an investor to choose a blue-chip stock? An income stock? etc. The Internet (p. 489) As pointed out in the last chapter, it is impossible to describe all the Web sites that deal with personal finance and investments. We will examine some Web sites that are logical starting points when evaluating stock investments. These include: • A corporation’s home page • Web sites like Yahoo, Google, MSN and other search engines • Professional advisory services like Standard & Poor’s, Morningstar, and Value Line Stock Advisory Services (p. 491) • In choosing among the hundreds of stock advisory services that charge fees for their information, the investor must be concerned about both the quality and the quantity of the information they provide. • Three popular advisory services are: 1. Value Line 2. Standard and Poors 3. Morningstar • A detailed research report for Dollar Tree is illustrated in Exhibit 14-7. Newspaper Coverage and Corporate News (p. 493 ) • Although some newspapers have eliminated or reduced the amount of financial coverage, The Wall Street Journal and some metropolitan newspapers still contain some information about corporate stocks. Not all newspapers print exactly the same information, but basic information is usually provided. • Use PPT slide 14-10. • Text Highlight: Exhibit 14-5 illustrates the type of information available on the Internet for the Gap, Inc--see p. 490. • Text Highlight: Have students look at the Investor web sites listed in Exhibit 14-6-see p. 491. • Use PPT slide 14-11. • Text Highlight: The Did You Know feature provides information about the Dow Jones Industrial Average— see page 491. • Text Highlight: Have students examine the sample research report for Dollar Tree illustrated in Exhibit 14-7--see p. 492. • Use PPT slide 14-12. • Transparency Master 14-1 illustrates how to read stock quotations in the newspaper. 14-9 CHAPTER 14 LECTURE OUTLINE • Stocks are listed alphabetically, so your first task is to move down the table to find the stock you’re interested in. • Typical information provided by newspapers includes the name of the company, stock symbol, and price information. • The federal government requires corporations selling new issues of securities to disclose information about corporate earnings, assets, and liabilities, products or services, and the qualifications of top management in a prospectus that they must give to investors. • After stock is sold, the federal government also requires that corporations report financial information to the Securities Exchange Commission (SEC). • To view information on the SEC web site, go to http://www.sec.gov. • In addition to a prospectus, all publicly owned corporations send their stockholders an annual report that contains detailed financial data. Instructional Suggestions • Text Highlight: Use the My Life feature to reinforce the need to evaluate stocks before investing. • Use PPT slide 14-13. • Discussion Question: What type of information is included in a corporation’s annual report? • Practice Quiz 14-2 (p. 493) 14-10 CHAPTER 14 LECTURE OUTLINE III. NUMERICAL MEASURES THAT INFLUENCE INVESTMENT DECISIONS (p. 494) Why Corporate Earnings Are Important (p. 494) • Many analysts believe that a corporation’s ability or inability to generate earnings in the future may be one of the most significant factors that accounts for an increase or decrease in the price of a stock. • Higher earnings generally equate to higher stock price. • Unfortunately, the reverse is also true. • It also helps to remember that the price for a share of stock is determined by what another investor is willing to pay for it. The term stock market bubble is used to describe a situation when stocks are trading at prices above their actual worth. • To help evaluate a stock issue, many investors calculate earnings per share and price-earnings ratios. • While these calculations are based on historical numbers, it is also possible to obtain projected earnings for most corporations. Other Factors that Influence the Price of a Stock (p. 496) • Today, many investors purchase stocks for dividend income. Because dividends are a distribution of a corporation’s earnings, these same investors must be concerned about the firm’s future earnings and the dividend payout. • The dividend payout is the percentage of a firm’s earnings paid to stockholders in cash. • In addition to the above numerical calculation, a dividend yield calculation can help investors compare returns for different investments. • The dividend yield is the annual dividend amount generated by an investment divided by the investment’s current price per share. • The total return calculation includes not only the yearly dollar amount of dividends as well as any increase or decrease in the purchase price of the investment. • The annualized holding period yield calculation takes into account the total return, the original investment, and the time the investment is held. • The beta is a measure reported in many financial publications that compares the volatility associated with a specific stock issue with the volatility of the Standard & Poor’s 500 stock index. • The beta for the Standard & Poor’s 500 Stock Index is 1.0. • The majority of stocks have betas between 0.5 and 2.0. Instructional Suggestions • Use PPT slide 14-14. • Text Highlight: You may want to review the calculations for earnings per share and price-earnings ratio discussed on pp. 494-495. • Text Highlight: You may want to review the material on Price/Earnings to Growth Ratio— See the Financial Planning Calculations boxed feature on page 496. • Text Highlight: How the time value of money can be used to help evaluate an investment is explained in the Financial Planning Calculations feature on page 498. • Use PPT slide 14-15. • Text Highlight: You may want to review the calculations for dividend payout, dividend yield, total return, and annualized holding period yield at this point in your lecture. • Use PPT slide 14-16. • Use PPT slide 14-17. 14-11 CHAPTER 14 LECTURE OUTLINE • Generally, conservative stocks have low betas and speculative stocks have high betas. • It is also possible to calculate a firm’s book value. Book value for a share of stock is determined by deducting all liabilities from the corporation’s assets and dividing the remainder by the number of outstanding shares of common stock. • You can also calculate a market-to-book ratio. The market-to-book ratio is calculated by dividing the market value of one share of stock by the book value for one share of stock. • A low market-to-book ratio could mean that the stock is undervalued and a high ratio could mean that a stock is overvalued. Investment Theories (p. 500) • Finally, investors often use three different investment theories to determine a stock’s value. • Fundamental analysis is a theory based on the assumption that a stock’s intrinsic or real value is determined by the future earnings of the company. Instructional Suggestions • Text Highlight: You may want to review the calculations for beta, book value, and market-to-book ratio at this point in your lecture. • Use PPT slide 14-18. • Use PPT slides 14-19 through 14- 21. • Discussion Question: Which investment theory do you think explains price movements in the stock market? • Technical theory is a theory based on the assumption that a stock’s market value is determined by the forces of supply and demand in the stock market as a whole, not on the expected earnings or the intrinsic value of an individual corporation’s stock. • The efficient-market hypothesis is based on the assumption that stock price movements are purely random. Advocates of the efficient market hypothesis believe it is useless to identify undervalued or overvalued stocks and the only way to achieve superior results is to pick riskier investments. • The My Life feature can be used to stress the importance of corporate earnings related to a stock’s price. • Practice Quiz 14-3. (p. 501) 14-12 CHAPTER 14 LECTURE OUTLINE IV. BUYING AND SELLING STOCKS (p. 501) • To purchase common or preferred stock, you generally have to work through a brokerage firm. In turn, your brokerage firm must buy the stock in either the primary market or the secondary market. • The primary market is a market in which an investor purchases financial securities (via an investment bank or other representative) from the issuer of these securities. • An investment bank is a financial firm that assists organizations in raising funds, usually by helping sell new security issues. • An initial public offering (IPO) occurs when a corporation sells stock to the general public for the first time. • Be Warned: the promise of quick profits often lures investors to purchase IPOs. Generally, an IPO is classified as a high-risk investment. • The secondary market is a market for existing financial securities that are currently traded between investors. Instructional Suggestions • Use PPT slide 14-22. • Discussion Question: What is the difference between the primary market and the secondary market? Secondary Markets for Stocks (p. 501) • To purchase common or preferred stock, the transaction is completed on a securities exchange or through the over- the-counter market. • A securities exchange is a marketplace where member brokers who are representing investors meet to buy and sell securities. • The New York Stock Exchange (now owned by the NYSE Euronext holding company) is one of the largest securities exchange in the world. • On a security exchange, a specialist buys or sells a particular stock in an effort to maintain an orderly market. • Various regional exchanges also transact stocks for corporations and investors. • The over-the-counter (OTC) market is a network of dealers who buy and sell the securities of corporations that are not listed on a securities exchange. • Most over-the-counter securities are traded through Nasdaq—an electronic marketplace for approximately 3,300 stocks. • In addition to providing price information, this computerized system allows investors to buy and sell shares of companies listed on Nasdaq. • Use PPT slide 14-23. • For more information on the NYSE go to http://www.nyse.com. • Use PPT slide 14-24. • For more information on Nasdaq, go to http://www.nasdaq.com. 14-13 CHAPTER 14 LECTURE OUTLINE Brokerage Firms and Account Executives (p. 502) • An account executive is a licensed individual who buys or sells securities; also called a stockbroker. • Needless to say, account executives may err in their investment recommendations. To help avoid a situation in which your account executive’s recommendations are automatically implemented, you should be actively involved in your investment program. • In particular, avoid letting your broker use his or her discretion with regard to your account without your approval. Should You Use a Full-Service or a Discount Brokerage Firm or Trade Online? (p. 502) • Today, a healthy competition exists between full-service, discount, and online brokerage firms. When deciding which to use you should consider: 1. The amount of research information that is available and how much it costs. 2. How much help you need when making an investment decision. 3. How easy it is to buy or sell stock and other securities. Commission Charges (p. 503) • Most brokerage firms have a minimum commission charge for buying or selling stock, usually between $5 and $25. Additional commission charges are based on the number of shares and the value of stock bought and sold. • Also, the commission charged by a full-service and discount brokerage firms is generally higher than the commission charged by online brokerage firms. • See Exhibit 14-8 for typical charges for various types of trades by a number of discount and online brokerage firms. Completing Stock Transactions (p. 504) • Once an investor and his or her account executive have decided on a particular transaction, the investor gives the account executive an order for that transaction. 1. A market order is a request that a stock be bought or sold at the current market price. 2. A limit order is a request that a stock be bought or sold at a specified price or better. 3. A stop-loss order is a request that an order be executed at the next available opportunity after the market price reaches a specified amount. Instructional Suggestions • Use PPT slides 14-25 and 14-26. • The Did You Know feature provides information about the Securities Investor Protection Corporation (SIPC). • Use PPT slide 14-27. • Text Highlight: The boxed material on page 503 provides information that will help determine if students should use a full service, discount, or online brokerage firm. • Text Highlight: You may want to discuss the five questions that can be used to help investors decide if they need a full-service, discount, or online brokerage firm—see page 503. • Discussion Question: How important are commissions when investing in stocks? • Use PPT slide 14-28. • Practice Quiz 14-4 (p. 505) 14-14 CHAPTER 14 LECTURE OUTLINE V. LONG-TERM AND SHORT-TERM INVESTMENT STRATEGIES (p. 505) • Generally, individuals who hold an investment for a long period of time are referred to as investors. Individuals who buy and then sell stocks within a short period of time are called speculators or traders. Instructional Suggestions • Use PPT slide 14-29. • Text Highlight: You may want to discuss the historical performance of stocks at this point in your class discussion— see page 505. Long-Term Techniques (p. 505) • Long-term investment strategies include: 1. The buy and hold technique 2. Dollar cost averaging—See Exhibit 14-9 3. Direct investment 4. Dividend reinvestment plans Short-Term Techniques (p. 507) • In addition to the long-term techniques presented in the preceding section, we discuss several short-term, speculative techniques. These methods are quite risky and should not be used by investors who do not fully understand the underlying risks. • For example, a day trader is an individual who buys and then later sells stocks and other securities in a very short period of time. Be warned: Most day traders lose money. • Other highly speculative techniques include buying stock on margin, selling short, and trading in options. • The Did You Know feature provides information about the history of “Wall Street.” (See page 505.) • Discussion Question: What type of person should invest in long-term stocks? • Text Highlight: You may want to discuss the Financial Planning for Life’s Situation feature “How Do I Pick a Winning Stock” at this point in your class discussion—see page 506. • Use PPT slide 14-30. • Text Highlight: You may want to discuss the My Life feature to reinforce the long-term and short-term techniques used by investors and speculators at this point in your class discussion-- see p. 507. Buying Stock on Margin (p. 508) • When buying stock on margin, an investor borrows part of the money necessary to buy a particular stock. • An example of a margin transaction for Microsoft stock is illustrated on p. 508. • If the value of a margined stock decreases to approximately sixty-five percent of the original purchase price, you may receive a margin call from the brokerage firm. After the margin call, you must pledge additional cash or securities to serve as collateral for the loan. • In addition to facing the possibility of larger dollar losses, you must pay interest on the money borrowed to purchase stock on margin. Selling Short (p. 508) • Investors oriented to greater risk often use a procedure called selling short to make money when the price of a security is falling. • Use Transparency Master 14-2 illustrates a margin transaction. • Discussion Question: Why would an investor use margin? • Discussion Question: Why would an investor use the selling short procedure? 14-15 CHAPTER 14 LECTURE OUTLINE • Selling short is selling stock that has been borrowed from a stockbroker and must be replaced at a later date. • The steps involved in selling short are illustrated for a short transaction for J.C. Penney stock on p. 509. • Before selling short, consider two factors. First, since the stock you borrow from your broker is actually owned by another investor, you must pay any dividends the stock earns before you replace the stock. • Second, to make money selling short, you must be correct in predicting that a stock will decrease in value. If the value of the stock increases you lose because you must replace the borrowed stock with stock purchased at a higher price. Trading in Options (p. 509) • An option gives an investor the right to buy or sell a stock at a predetermined price during a specified period of time. Instructional Suggestions • Use Transparency Master 14-3 illustrates selling short. 1. A call option is sold by a stockholder and gives the purchaser the right to buy 100 shares of a stock at a guaranteed price before a specified expiration date. 2. A put option is the right to sell 100 shares of a stock at a guaranteed price before a specified expiration date. • Practice Quiz 14-5 (p. 510) 14-16 CONCLUDING ACTIVITIES • Point out the Dashboard and My Life Stages for Managing My Stock Investment features, chapter summary, and key terms (p. 510). • Discuss selected end-of-chapter key formulas, self-test problems, financial planning problems, financial planning activities, financial planning case, and continuing case (p. 512). • Use the Chapter Quiz in the Instructor’s Manual. WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 14 Sheet 58 Corporate Stock Evaluation Sheet 59 Investment Broker Comparison CHAPTER 14 QUIZ ANSWERS True-False Multiple Choice 1. T (p. 482) 6. B (p. 483) 2. F (p. 482) 7. B (p. 487) 3. T (p. 485) 8. A (p. 494) 4. F (p. 494) 9. D (p. 489) 5. T (p. 499) 10. C (p. 501) 14-17 Name ________________________________________ Date ____________________________ CHAPTER 14 QUIZ TRUE-FALSE _____1. O One reason corporations sell common stock is to finance their business start-up costs. _____2. A corporation is required by law to pay dividends to stockholders. _____3. The record date is the date when a stockholder must be registered on the corporation’s books in order to receive dividends. _____4. A firm’s projected future earnings have very little or no impact on the value of a corporation’s stock. _____5. The book value for a share of stock is determined by deducting all liabilities from the corporation’s assets and dividing the remainder by the number of outstanding shares of common stock. MULTIPLE CHOICE _____6. At an annual meeting, stockholders can either vote in person or by ____________. a. ad hoc ballot. b. proxy. c. record ballot. d. cumulative feature. _____7. A stock split a. always guarantees that the investor will make money. b. enables management to bring a stock’s price into an “ideal” price range. c. is always used to raise the stock’s market price. d. doesn’t affect the market price of a share of the corporation’s stock. _____8. Earnings per share are calculated by dividing a. a firm’s after-tax income by number of shares outstanding. b. the dividends paid to an investor by the number of shares an investor owns. c. before tax income by the number of shares outstanding. d. a firm’s total earnings by the total amount of dividends paid to investors. _____9. A stock that follows the business cycle of advances and declines in the economy is called a(n) ____________ stock. a. blue-chip b. income c. growth d. cyclical _____10. When stocks are traded between investors, they are traded in the ____________ market. a. investment banking b. primary c. secondary d. efficient. 14-18 SUPPLEMENTARY LECTURE This lecture can be used to illustrate the need for preparing for an investment program before the first investment is purchased and should be used to introduce the material in Chapter 14—Investing in Stocks. Introduction Many beginning investors want to just “jump in” and begin an investment program without any preparation. It always helps to have your financial affairs in order before taking the “plunge” and purchasing stocks. Quick Test—Are You Ready? For each of the following five statements, select “Yes” or “No” to indicate your behavior regarding these investment activities. 1. Yes No My investment goals are written down. 2. Yes No When making investment decisions, I understand the concept of asset allocation. 3. Yes No I understand how investors can profit from stock investments. 4. Yes No I know how to evaluate a stock issue. 5. Yes No I have enough money to begin an investment program. What’s the Next Step? For many investors, the last statement may be the stumbling block. Most people know they should save money that can be used to fund an investment program. And yet, too often the money isn’t there. Often, these same people put off beginning an investment program until next year and next year never seems to come. At this point in your lecture, you may want to review the suggestions for obtaining the money that is needed to fund an investment program that were presented in Chapter 13. Below is a quick summary of those ideas. 1. Pay yourself first. Each month, pay your monthly bills, save or invest a reasonable amount, and use whatever money is left over for personal expenses or entertainment. 2. Take advantage of employer sponsored retirement programs. Many employers will match part or all of the contributions you make to a retirement program. 3. Participate in an elective savings program. You can elect to have money withheld from your paycheck each payday and automatically deposited in a savings or investment account. 4. Make a special savings effort one or two months each year. Many financial planners recommend that you cut back to the basics for one or two months each year. 14-19 ANSWERS TO PRACTICE QUIZ QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE. PRACTICE QUIZZES Practice Quiz 14-1 (p. 488) 1. Why do corporations issue common stock? Corporations sell common stock to finance their business start-up costs and help pay for expansion and their ongoing business activities. Since common stock is a form of equity financing, it does not have to be repaid and dividends are not mandatory. (p. 482) 2. Describe two reasons why stockholders purchase common stock. Basically, there are two ways that an investor can make money with a common stock investment: (1) income from dividends and (2) dollar appreciation of stock value. Note: there is a possibility of increased value from stock splits but there are no guarantees. (pp. 483-488) 3. Why do corporations split their stock? Is a stock split good or bad for investors? A corporation splits its stock because management has a theoretical ideal price range for the firm’s stock. If the market price of the stock rises above the ideal price range, a stock split brings the market price back in line. Also, a decision to split a company’s stock makes the stock more attractive to the investing public. (Be Warned: There is no evidence to support that a corporation’s stock performance is improved over a long time period because of a stock split.) (pp. 487-488) 4. What is the most important priority that a preferred stockholder has compared to common stockholders? The most important priority that an investor in preferred stock enjoys is receiving cash dividends before common stockholders are paid any cash dividends. (p. 488) Practice Quiz 14-2 (p. 493) 1. How would you define: (a) a blue-chip stock, (b) a cyclical stock, (c) a defensive stock, (d) a growth stock, (e) an income stock, (f) a large-cap stock, (g) a midcap stock, (h) a small-cap stock, (i) a micro- cap stock, and (j) a penny stock? (p.489) Type of Stock Characteristics of This Type of Investment Blue chip A safe investment that generally attracts conservative investors. Cyclical A stock that follows the business cycle of advances and declines in the economy. Defensive A stock that provides consistent dividends and stable earnings during declines in the economy. Growth A stock issued by a corporation that has the potential of earning profits above the average profits of all firms in the economy. Income An investment that pays higher-than-average dividends. Large cap A stock issued by a corporation that has a large amount of market capitalization in excess of $10 billion. Midcap A stock issued by a corporation that has market capitalization of between $2 and $10 billion. 14-20 Small cap A stock issued by a company that has a market capitalization of between $300 million and $2 billion. Micro cap A stock issued by a company that has a market capitalization of $300 million or less. Penny stock A stock that typically sells for a low price often defined as $1 or less per share (or in some cases, less than $5 per share). 2. Which type of stock could help you obtain your investment and financial goals? Justify your choice? While student answers may vary, it may help to point out why some investors choose more growth stocks compared to more conservative stock issues. (p. 489) 3. What sources of information would you use to evaluate a stock issue? The Internet and newspapers are the most readily available sources of information about stock investments. In this section, classifications of stocks, stock advisory services, and corporate news were also discussed. You may also want to point that stock advisory services typically provide the most detailed information about stocks. (pp. 489-493) Practice Quiz 14-3 (p. 501) 1. Explain the relationship between earnings and a stock’s market value. Many analysts believe that a corporation’s ability and inability to generate earnings in the future may be one of the most significant factors that account for an increase or decrease in the value of a stock. Simply put, higher earnings generally equate to higher stock value. Unfortunately, the reverse is also true. If a corporation's earnings decline, generally the stock’s value will also decline. (p. 494) 2. Why are earnings per share and price-earnings ratios important? Earnings per share is a corporation’s after-tax income divided by the number of outstanding shares of the corporation’s stock. The price-earnings ratio (PE) is the price per share of the corporation’s stock divided by the corporation’s earnings per share. Both calculations help investors “dig in” a little deeper and provide investors with more than just the corporation’s after-tax income amount. (pp. 494- 495) 3. What are the formulas for dividend payout, dividend yield, total return, annualized holding period yield, book value, and market-to-book ratio? The dividend payout is the annual dividend amount divided by the earnings per share. The dividend yield is the annual dividend amount divided by the current price per share. The total return is the dividends plus capital gain. The annualized holding period yield calculation takes into account the total return, the original investment, and the time the investment is held. The formula is Annualized Holding = Total Return × I Period Yield Original Investment N (Where N = number of years the investment is held) The book value for a share of stock is determined by deducting all liabilities from the corporation’s assets and dividing the remainder by the number of outstanding shares of common stock. 14-21 The market-to-book ratio is the current market value per share of stock divided by the book value per share of stock (pp. 496-500) 4. Explain how fundamental analysis, technical analysis, or the efficient market hypothesis can be used to best describe price movements for the stock market? Fundamental analysis is based on the assumption that stock’s intrinsic or real value is determined by the future earnings of the company. Technical analysis is based on the assumption that a stock’s market value is determined by the forces of supply and demand in the stock market as a whole. The efficient market hypothesis is based on the assumption that stock price movements are purely random. With regard to the issue of one theory explaining price moves for the stock market better than another theory, student answers will vary. (p. 500) Practice Quiz 14-4 (p. 505) 1. What is the difference between the primary market and the secondary market? The primary market is a market in which an investor purchases financial securities (via an investment bank or other representative) from the issuer of those securities. The secondary market is a market for existing financial securities that are currently traded between investors. (p. 501) 2. Describe the types of orders that are used to buy or sell stocks. A market order is a request that a stock be bought or sold at the current market price. A limit order is a request that a stock be bought or sold at a specified price or better. A stop-loss order is a request that an order be executed at the next available opportunity after the market price reaches a specified amount. (p. 504) 3. Assume you want to purchase stock. Would you use a full-service broker or a discount broker? Would you ever trade stocks online? While students must answer this question, you may want to review the material on pages 502-503. Also, you may want to review Exhibit 14-8—Typical Commission Charges for Online Stock Transactions on page 503. At this time, online trading is becoming more popular because of the lower commission charges. (pp. 502-503) Practice Quiz 14-5 (p. 510) 1. How can an investor make money using the buy and hold technique? When investors use a buy and hold technique, investors can make money in one of two ways. First, they are entitled to dividends. Second, the price of the stock may go up. There is also the possibility of gain because of a stock split. Be warned: there are no guarantees that a stock split will increase the value of your stock investments. (p. 505) 2. What is the advantage of using dollar cost averaging? If they use dollar-cost averaging, investors can avoid the common pitfall of buying high and selling low. (p. 506) 3. Explain the difference between direct investment plans and dividend reinvestment plans. Direct investment plans allow stockholders to purchase stocks directly from a corporation without having to use an account executive or a brokerage firm. A dividend reinvestment plan allows current stockholders the option of reinvesting their cash dividends in the stock of a corporation. (p. 506) 4. Why would an investor buy stock on margin? When buying stock on margin an investor borrows part of the money necessary to buy a particular stock. The financial leverage of borrowed money allows the stockholder to purchase a larger number 14-22 of shares of stock. If the price of the stock increases, the stockholder makes more money because he or she owns more shares. Unfortunately, the reverse is true. If the price of the stock decreases the stockholder loses more money because he or she owns more shares. (p. 508) 5. Why would an investor use the selling short technique? Stockholders who think the market value of a stock will decrease may want to use the selling short technique. When you sell short, you sell today, knowing that you must buy or cover your short transaction at a later date—hopefully at a lower price. (p. 508) FINANCIAL PLANNING PROBLEMS (p. 515) 1. Calculating Dividend Amounts. Betty and John Martinez own 220 shares of ExxonMobil common stock. ExxonMobil’s annual dividend is $2.28 per share. What is the amount of the dividend check that the Martinez couple will receive for this year? Quarterly dividend = 220 shares  $2.28 = $501.60 Learning Objective: 14-1 Topic: Common and Preferred Stocks Level of Difficulty: Easy Bloom’s Tag: Application 2. Determining the Number of Shares after a Stock Split. In March, stockholders of 3D Systems Corporation approved a two for one stock split. After the split, how many shares of 3D Systems stock will an investor have if she or he owned 230 shares before the split? 230 shares before the split  (2/1) = 460 shares after the split. Learning Objective: 1 Topic: Common and Preferred Stocks Level of Difficulty: Easy Bloom’s Tag: Application 3. Calculating Total Return. Tammy Jackson purchased 100 shares of All-American Manufacturing Company stock at $31.50 a share. One year later, she sold the stock for $38 a share. She paid her broker a $15 commission when she purchased the stock and a $29 commission when she sold it. During the 12 months that she owned the stock, she received $160 in dividends. Calculate Tammy’s total return on this investment. Current Return = $160 in dividends over the past 12 months Purchase Price = $31.50  100 shares + $15 commission = $3,165 Selling Price = $38  100 shares - $29 commission = $3,771 Capital gain = $3,771 - $3,165 = $606 Total Return = $160 Current Return + $606 capital gain or $766. Learning Objective: 14-1 Topic: Common and Preferred Stocks Level of Difficulty: Difficult Bloom’s Tag: Application 14-23 4. Calculating Total Return. Marie and Bob Houmas purchased 200 shares of General Electric stock for $23 a share. One year later, they sold the stock for $31 a share. They paid their broker a $32 commission when they purchased the stock and a $41 commission when they sold it. During the 12 months they owned the stock, they received $152 in dividends. Calculate the total return on this investment. Current Return = $152 in dividends over the past 12 months Purchase Price = $23  200 shares + $32 commission = $4,632 Selling Price = $31  200 shares - $41 commission = $6,159 Capital Gain = $6,159 - $4,632 = $1,527 Total Return = $152 Current Return + $1,527 Capital Gain or $1,679 Learning Objective: 14-1 Topic: Common and Preferred Stocks Level of Difficulty: Difficult Bloom’s Tag: Application 5. Determining a Preferred Dividend Amount. James Hayes owns 370 shares of Ohio Utility preferred stock. If this preferred stock issue pays $2.80 per share, what is the total dollar amount Mr. Hayes will receive in one year? $2.80 per share  370 shares = $1,036 Total dividends Learning Objective: 14-1 Topic: Common and Preferred Stocks Level of Difficulty: Easy Bloom’s Tag: Application 6. Calculating Dividend Payout. Assume you own shares in Honeywell, Inc. and that the company currently earns $3.69 per share and pays annual dividend payments that total $1.64 a share each year. Calculate the dividend payout for Honeywell. The dividend payout is 44.4%. Dividend payout = Dividend amount Earnings per share = $1.64 $3.69 = 0.4444 = 44.44% Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Medium Bloom’s Tag: Application 7. Compounding Investment Returns. Nancy Cardoza invested $2,450 in ExxonMobil stock because her research indicated the company should average an 8 percent return over the next 4 years. If ExxonMobil does earn 8 percent each year, what will her $2,450 investment be worth at the end of 4 14-24 years? (To solve this problem, you may want to use Exhibit 1-A in the appendix that follows chapter 1.) Ms. Cardoza's investment will be worth $3,332, as calculated below. $2,450 ExxonMobil investment x 1.360 table factor from Exhibit 1-A = $3,332 Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Medium Bloom’s Tag: Application 8. Compounding Dividend Amounts. Carl Patterson likes investing in stocks that pay dividends. Carl owns 25 shares of a local utility company. The stock pays a regular annual dividend in the amount of $3.00 per share and the company has indicated that the dividend will stay the same for a long time. If Carl reinvests his dividends each year and the dividends earn a return of 6 percent each year, how much will Carl accumulate in 15 years? (To solve this problem, you may want to use Exhibit 1-B in the appendix that follows Chapter 1.) Carl's investment will be worth $1,745.70 as calculated below. $3.00 per share dividend x 25 shares = $75 income per year $75 income per year x 23.276 table factor from Exhibit 1-B = $1,745.70 Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Medium Bloom’s Tag: Application 9. Calculating Return on Investment. Two years ago, you purchased 100 shares of Coca-Cola Company. Your purchase price was $33 a share, plus a total commission of $29 to purchase the stock. During the last two years, you have received the following dividend amounts: $0.94 per share for the first year, and $1.12 per share, the second year. Also assume that at the end of two years, you sold your Coca-Cola stock for $40 a share minus a total commission of $34 to sell the stock. a. Calculate the dividend yield for your Coca Cola stock at the time you purchased it. $0.94 per share first year dividend ÷ $33 original purchase price = 0.0285 = 2.85 percent. b. Calculate the dividend yield for your Coca-Cola stock at the time you sold it. $1.12 per share second year dividend ÷ $40 share selling price = 0.028 = 2.80 percent c. Calculate the total return for your Coca-Cola investment when you sold the stock at the end of two years. Current Return = ($0.94 per share + $1.12 per share)  100 shares = $206 Capital Gain = ($40 per share selling price - $33 per share purchase price)  100 shares = $700 – ($29 + $34) commissions = $637 Total Return = $206 Dividends + $637 Capital Gain = $843 d. Calculate the annualized holding period yield for your Coca-Cola investment at the end of the two-year period. 14-25 Original investment = (100 shares x $33 purchase price per share) + $29 commission = $3,329 Annualized holding period yield = $843 total return / $3,329 initial investment x 1/2 = 0.1266 = 12.66% Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Difficult Bloom’s Tag: Application 10. Calculating Earnings Per Share, Price-Earnings Ratio, and Book Value. As a stockholder in Bozo Oil Company, you receive its annual report. In the financial statements, the firm has reported assets of $9 million, liabilities of $5 million, after-tax earnings of $2 million, and 750,000 outstanding shares of common stock. (LO14-3) a. Calculate the earnings per share of Bozo Oil’s common stock. After Tax Income / Number of Shares Outstanding = EPS $2.67 per share 750,000shares $2,000,000  b. Assuming that a share of Bozo Oil’s common stock has a market value of $40, what is the firm’s price-earnings ratio? Price per share / Earnings per share = P/E Ratio c. Calculate the book value of a share of Bozo Oil’s common stock. (Assets – Liabilities) / Number of shares outstanding = Book value $5.33 per share 750,000shares $9,000,000$5,000,000  Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Medium Bloom’s Tag: Application 11. Calculating Beta. Thompson Home Remodeling has a 1.40 beta. If the overall stock market increases by 7 percent, how much will Thompson Home Remodeling change? Volatility for a stock = Increase in overall market x Beta for a specific stock 7 percent x 1.40 = 0.098 = 9.80 percent increase for Thompson Home Remodeling 14.98 P/E Ratio $2.67 earnings per share $ 40. 00  14-26 Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Easy Bloom’s Tag: Application 12. Calculating Ratios. According to the financial statements for Samson Electronics, Inc., the firm has total assets valued at $310 million. It also has total liabilities of $190 million. Company records indicate that the firm has issued 2 million shares of stock. a. Based on the above information, calculate the book value for a share of Samson Electronics. The book value for a share of Samson Electronics is $60, as calculated below. $310 million - $190 million ÷ 2 million shares = $60. b. If a share of Samson Electronics, Inc. currently has a market value of $50 a share, what is the market-to-book ratio? (p. 461) $50 market value ÷ $60 book value = 0.8333 c. Based on the market-to-book ratio, is a share of Samson Electronics overpriced or underpriced? Explain your answer. A low market-to-book ratio (less than 1) could mean that the stock is undervalued and a high market- to-book ratio (higher than 1)could mean that a stock is overvalued. With a market-to-book value of 0.8333, Samson Electronics might be undervalued. Still, a better approach would be to use this calculation along with other calculations to evaluate this stock. Learning Objective: 14-3 Topic: Numerical Measures that Influence Investment Decisions Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 13. Using Dollar Cost Averaging. For four years, Mary Nations invested $4,000 each year in America Bank stock. The stock was selling for $34 in 2010, for $48 in 2011, for $37 in 2012, and $52 in 2013. a. What is Mary’s total investment in America Bank? Mary’s total investment is $16,000, as illustrated below. $4,000 x 4 years = $16,000 total investment. b. After four years, how many shares does Mary own? Mary owns 385.9 shares, as illustrated below. 2010 $4,000 ÷ $34 = 117.6 shares 2011 $4,000  $48 = 83.3 shares 2012 $4,000  $37 = 108.1 shares 2013 $4,000  $52 = 76.9 shares Total Shares 385.9 shares c. What is the average cost per share of Mary’s investment? The average cost per share is $41.46, as illustrated below. $16,000 total investment  385.9 shares = $41.46 per share cost. 14-27 Learning Objective: 14-5 Topic: Long-Term and Short-Term Investment Strategies Level of Difficulty: Difficult Bloom’s Tag: Application 14. Using Margin. Bill Campbell invested $4,000 and borrowed $4,000 to purchase shares in Walmart. At the time of investment, Walmart stock was selling for $70 a share. a. If Bill paid $30 commission, how many shares could Bill buy if he used only his own money and did not use margin? $4,000 - $30 commission = $3,970 funds for investment after commission $3,970 ÷ $70 a share = 56.7 shares b. If Bill paid $50 commission, how many shares could Bill buy if he used his $4,000 and borrowed $4,000 on margin to buy Wal-Mart stock? $4,000 + $4,000 Margin = $8,000 total funds available for investment $8,000 - $50 commission = $7,950 funds for investment after commission $7,950 ÷ $70 a share = 113.6 shares c. Assuming that Bill did use margin, paid $90 commission to sell his stock, and sold his Wal-Mart stock for $77, how much profit did he make on his Wal-Mart investment? $77 price per share when sold - $70 per share purchase price = $7 per share profit $7 per share profit  113.6 number of shares using margin = $795.20 profit $795.20 - $90 commission = $705.20 total profit after commission Learning Objective: 14-5 Topic: Long-Term and Short-Term Investment Strategies Level of Difficulty: Difficult Bloom’s Tag: Application 15. Selling Short. After researching Best Buy common stock, Sally Jackson is convinced that the stock is overpriced. She contacts her account executive and arranges to sell short 200 shares of Best Buy. At the time of the sale, a share of common stock had a value of $27. Three months later, Best Buy was selling for $18 a share and Sally instructs her broker to cover her short transaction. Total commissions to buy and sell the stock were $74. What is her profit for this short transaction? $27 per share price when sold - $18 per share when purchased = $9 per share profit $9  200 shares = $1,800 profit before commissions $1,800 - $74 = $1,726 total profit after commissions Learning Objective: 14-5 Topic: Long-Term and Short-Term Investment Strategies Level of Difficulty: Medium Bloom’s Tag: Application 14-28 FINANCIAL PLANNING ACTIVITIES (p. 516) 1. Surveying Investors. Survey investors who own stock then explain, in a short paragraph, their reasons for owning stock. (LO 14-1) While student answers will vary, the people they survey should have purchased stock for income from dividends and dollar appreciation of stock value. Some investors might have also mentioned possible increase in value from stock splits. 2. Researching Stocks. Use the Internet to find the following information for the four stocks listed below in the chart. (LO 14.2) Date _____________________ Website___________________ Stock Stock Symbol 52-Week High 52-Week Low Dividend Dividend Yield Close Price Microsoft Clorox IBM Pfizer While student answers will vary depending on the date for obtaining the information and the source of the information, you may want to use this activity to review the sources of information that were discussed in this chapter. 3. Using Stock Advisory Services. Pick a stock of interest to you and research the company at the library by examining the information contained in reports published by Value Line, Standard & Poor’s, or Morningstar or business periodicals like BusinessWeek, Money, or Kiplinger’s Personal Finance Magazine. Then, write a one or two page summary of your findings. Based on your research would you still want to invest in this stock? Why or why not? (LO 14-2) Although student answers will vary, you may want to use this question as a reason to discuss the type of information provided by investor services like Value Line, Standard & Poor’s, and Morningstar— See Exhibit 14- 7 and pages 491-493. 4. Using the Yahoo! Finance Website. Visit the Yahoo! Finance Website and evaluate one of the corporations listed below. To complete this activity, follow these steps. (LO 14-2) a. Go to http://www.finance.yahoo.com. b. Choose one of the following three corporations, enter its stock ticker symbol, and click on the Look Up button: General Electric (GE), Facebook (FB), or Abbott Laboratories (ABT). c. For your corporation, print out the information for the profile, 2-year chart, and analyst opinion. d. Based on the information included in this research report, would you invest in this corporation? Explain your answer. Student answers will vary depending on which corporation was chosen. 14-29 5. Using Long-Term Investment Techniques. Interview people who have used the long-term techniques of buy and hold, dollar cost averaging, direct investment plans, and dividend reinvestment plans. Describe your findings. (LO 14-5) These techniques are all used by long-term, conservative investors. You may want to remind students that investing for most people is built on a long-term financial plan. In fact, they should not expect to “double their money overnight.” 6. Analyzing Short-Term Investments. Prepare a chart that describes the similarities and differences among day trading, buying stock on margin, and selling short. (LO 14-5) A day trader is an individual who buys and then later sells stocks and other securities in a very short period of time. When buying on margin, an investor borrows part of the money necessary to buy a particular stock. Because the investor owns more stock, he or she makes more money if the stock increases in value. Selling short is selling stock that has been borrowed from a stockbroker and must be replaced at a later date. Simply put, the investor sells the borrowed stock at a high price, and then replaces the borrowed stock with stock purchased later at a lower price. All three short-term methods described in this question are speculative and should not be used by anyone who does not understand the risks involved. 7. Practicing Your Investment Skills. Today, you can practice your investing skills by playing a virtual stock game. To complete this activity, use an Internet search engine like Google or Yahoo! Begin by entering “virtual stock game” in the search box. Select one of the virtual stock games and then play the game for a specific time period. At the end of the time period, prepare a two-page report that describes what you learned by playing the virtual stock game. (LO 14-5) While student answers may vary, this activity is “good practice” for your students because it allows students to invest without having to spend any “real” money. FINANCIAL PLANNING CASE Research Information Available from Value Line (p. 517) 1. Based on the research provided by Value Line, would you buy Dollar Tree’s common stock? Justify your answer. Each student will have to answer this question based on his or her own investment objectives. All answers should be based on the information contained in Exhibit 14-7. 2. What other investment information would you need to evaluate Dollar Tree’s common stock? Where would you obtain this information? It would be possible to compare the information contained in the Value Line report with similar reports published by Morningstar and Standard & Poor’s. This information would be available in most libraries. It would also be possible to talk to a full-service broker regarding this stock. You could also use the Internet to research Dollar Tree. Finally, it would be possible to research the company through business periodicals or an annual report. Again, many libraries have these publications. 3. On Monday, February 25, 2013, Dollar Tree’s common stock was selling for $41 per share. Using the Internet, determine the current price for a share of Dollar Tree’s common stock. Based on this information, would your Dollar Tree investment have been profitable if you had purchased the common stock for $41 a share? (Hint: Dollar Tree’s stock is listed on the Nasdaq over-the-counter market and its stock symbol is DLTR.) 14-30 This answer will depend on if the current price obtained by students is higher or lower than the price on February 25, 2013. 4. Assuming that you purchased Dollar Tree stock on Monday, February 25, 2013 and based on your answer to Question 3, would you want to hold or sell your Dollar Tree stock? Explain your answer. The answer for this question depends on two factors. First, has Dollar Tree stock increased or decreased in value. Second, and more importantly, Dollar Tree must be evaluated at the present time. Investors cannot rely on research that is outdated. An investment should always be evaluated using the most current information that is available. CONTINUING CASE Investing in Stocks (p. 518) 1. What are the ways that Shelby and Mark might earn money from stock investments? What are the risks involved? Basically, there are two ways to make money from stock investments: income from dividends and dollar appreciation of stock value. In addition to dividend income and dollar appreciation, a stock split may affect the value of a corporation’s stock. For investors, the risks associated with stock investing are real. A corporation’s board of directors can vote to omit dividend payments to stockholders. Also, an investment in stock can decrease in value. A number of factors can cause a stock’s value to decrease— lower or no profits, decreased demand for the company’s products, etc. Finally, a stock may become worthless if the company files for bankruptcy. 2. If Shelly and Mark want to use the Internet to evaluate stocks, what are four Web Sites that can help them and what information do they provide? While student answers may vary, there are a large number of investment Web sites that can be used to obtain information about a specific stock investment. Certainly stock advisory services, including Morningstar, Value Line, and Standard & Poor’s should be mentioned in the answer to this question. More general sites like Yahoo! Finance may also be mentioned. Information obtained from quality stock websites should include much of the information that is included in the Value Line report for Dollar Tree—see Exhibit 14-7, 3. Explain how Shelby and Mark might use the Personal Financial Planner sheet Number 58 Corporate Stock Evaluation. While no checklist can serve as a foolproof guide for choosing a common or preferred stock, the twenty- two questions contained in this Personal Financial Planner sheet can help students evaluate a potential stock investment. 14-31 TM 14-1 Financial Information about Common Stock Given in The Wall Street Journal 14-32 TM 14-2 A Margin Transaction for Ford Stock January 2, 2013—The Buy Side April 22, 2013—The Sell Side 14-33 TM 14-3 An Example of Selling Short using Exxon Mobil stock January 6, 2013—The Short Sale (Steps 1 & 2) May 17, 2013—The Short Cover (Steps 3 & 4) 14-34 Name ______________________________________ Chapt er 14: I nv est ing in St ocks C U M U L A T I V E P R E F E R R E D S T O C K D I V I D E N D R E I N V E S T M E N T P L A A NN N U A L I Z E D H O L D I N G P E R I O D Y I E L D E F F I C I E N T M A R K E T T H E O R Y O V E R T H E C O U N T E R M A R K E T D I R E C T I N V E S T M E N T P L A N F U N D A M E N T A L A N A L Y S I S D O L L A R C O S T A V E R A G I N G S E C U R I T I E S E X C H A N G E P R I C E E A R N I N G S R A T I O D I S C R E T I O N A R Y O R D E R T E C H N I C A L A N A L Y S I S E A R N I N G S P E R S H A R E A C C O U N T E X E C U T I V S E C O N D A R Y M A R K EE T I N V E S T M E N T B A N K D E F E N S I V E S T O C K C A P I T A L I Z A T I O N S M A L L C A P S T O C K P R I M A R Y M A R K E T L A R G E C A P S T O C C Y C L I C A L S T O C KK B L U E C H I P S T O C K S E L L I N G S H O R T C U R R E N T Y I E L D T O T A L R E T U R N M A R K E T O R D E R I N C O M E S T O C K G R O W T H S T O C K S T O C K S P L I T S P E C I A L I S T S E C U R I T I E S R E C O R D D A T E P E N N Y S T O C K L I M I T O R D E R S T O P O R D E R B O O K V A L U E R O U N D L O T P A R V A L U E C H U R N I N G O P T I O N O D D L O T N A S D A Q M A R G I N P R O X Y B E T A I P O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993