Chapter 12

Ways to make money from stock ownership

: dividends ( a distribution of company profits to the owners of the company(stockholders), capital gains (appreciation of stock value), possible increased value from stock splits.

How to evaluate a company when buying stock

: look for market potential for sales increases, continuous innovation, a worthwhile profit margin, good labor and personal relations, executive compensation within industry norms, does the company have a short range or long range outlook with regard to profits? Invest only in firms whose business models you fully understand (you understand how they make their money), Be wary of companies that have a lot of debt.

Difference between common stock and preferred stock

Common stock: elects the board of directors, vote on important corporate matters Preferred stock: paid dividends before common stockholders, the dollar value of dividend is fixed and known before you buy the stock (safer because dividend is known).

Figure the costs when buying stock and the proceeds when selling stock

Costs when purchasing stock: # of shares X price per share plus commission. Costs when selling a stock:# of shares X price per share minus commission.

debt to equity ratio

Debt to Equity ratio= Long term DEbt/ Shareholder's Equity Indicates the proportion of equity vs. the debt the company is using to finance its assets. * lower the better

Understand earnings per share:

EPS= profit- dividends # outstanding shares (look for positive trends that show company is finding more ways to make money) * compare companies to others in the same industry.

Understand dividend yield

It is the yearly dollar amount of dividends generated by an investment dividend by the investment's current market value. An increase in current yield (dividend yield) is considered a healthy sign. Allows you to compare your dividend return to other types of returns on other investments.

How do you determine how much debt is too much?

The use of debt to generate more earnings is good, as long as earnings are increased by more than the debt cost (interest). the max allowable debt to equity ratio is 1.5 * a company with very low debt may indicate a company is not taking advantage of the increased profits that financial leverage can provide. Too much debt can lead to lower dividends, and more debt will have higher interest potentially lowering your return.

What do you own if you own stock?

Your stock represents your ownership or (Equity) in a company.

Where to find information when evaluating stock:

a corporation's website, finance.yahoo.com ( stock screener), Moneycentral.msn.com ( stock scouter), Magazines- money, kiplinger's, personal finance magazine, etc.

Dividend reinvestment plan

a plan that allows current stock holders the option to reinvest or use their cash dividends to purchase stock of the corporation

Dividends -

are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders

limit order

is an order to buy a security at no more than a specific price, or to sell a security at no less than a specific price Limit orders are used when the trader wishes to control price rather than certainty of execution

primary market

is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain bonds through the sale of a new stock or bond issue.

IPO

occurs when a corporation sells stock to the general public for the first time

Why do corporations sell stock?

to raise money to expand a business, develop a product, build a factory, etc. To help pay for ongoing business expenses. Unlike a loan or a bond issue, the corporation does not have to repay the money.

PE ratio (both trailing and forward):

P/E = market value per share Earnings Per Share The PE ratio is used to compare firms *within the same industry. P/E shows how much investors are willing to pay per dollar of earnings.lower P/E is more attractive, because it means you will have higher earnings per dollar.(high P/E means there is confidence in the stock/ may be overvalued.) ( low P/E indicates a good value in stock but may also indicate something is wrong.) Current or Trailing P/E is the stock's price divided by EPS for the previous 12 months. Forward P/E is the price dividend by the Wall Street estimate of EPS for the coming year.(forward P/E will be lower if the earnings are expected to grow

Dollar cost averaging

a long term technique used by investors who purchase an equal dollar amount of the same stock at equal intervals.

Direct investment plan

a plan that allows stock holders to purchase stock directly from a corporation without having to use an account executive or a brokerage firm

secondary market

also called aftermarket, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold.

Stock split

A stock split or stock divide increases the number of shares in a public company. for example, a company with 100 shares of stock priced at $50 per share. The market capitalization is 100 × $50, or $5000. The company splits its stock 2-for-1. There are now 200 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $25.

return on assets:

ROA = Net income/ Total assets (%) Shows how efficiently a company generates earnings from its assets. (compare within an industry) * the Higher the ROA the better

Return on Equity or Return on investment:

ROE = Net income (profit)/AVG Shareholder Equity Is a measure of how efficient a company is a generating profits. * view ROE from the past 5-10 years to get a good idea of a company's growth, and compare to others. ** the higher the ROE the better

Beta:

compares the stock's volatility to the S&P 500 index using returns over the past 5 years. Bets of 1: it moves in sync with the S&P 500 and is considered a steady stock. Beta of 2.5: the stock moves 25% when the S&P moves 10% (up or down). Beta of 0.7: the stock moves 7% when the S&P moves 10% (up or down)

market order-

is a buy or sell order to be executed immediately at current market prices. As long as there are willing sellers and buyers, market orders are filled. Market orders are therefore used when certainty of execution is a priority over price of execution