What are stocks? Chapter 2 of "investing 101"
Buy-and-hold investors invest in companies that have withstood the test of time
Page 34 Chapter 2 *What are stocks?* It's time to learn all about stocks, from what they are, to all the different types available to what they could mean for your portfolio. B_y-a_d-h__d i_______s i_____t i_ c_______s t___t h___e w______d t_e t___t o_ t___e. Traders, on the other hand, take a more active approach in investing, placing more emphasis on stock price movement than on the real value of the company. Regardless of which strategy you apply to your holdings, the same rule applies: know what you are and why you are buying or selling BEFORE you make any trades.
Companies whose earnings are strongly tied to the business cycle
Page 47 Cyclical, defensive, value and penny stocks More stock types C_______s w____e e_______s a_e s_____y t__d t_ t_e b_____s c____e are considered to be cyclical. When the economy picks up momentum, these stocks follow this positive trend. When the economy slows down, these stocks (correspondingly) slow down. Cyclical stocks would include companies like United Airlines (NASDAQ: UAL)(Personal note: I would imagine because travel is often a luxury that only people in a booming or relatively prosperous economy can afford?)
Defensive, produce things most people cannot live without
Page 47 D______e stocks, on the other hand, are relatively stable under most economic conditions, no matter how the market is faring. Stocks that fall into this category include food companies, drug manufacturers and utility companies. For the most part, these companies p_____e t____s p_____e c______t l___e w______t, no matter what the economic climate is at any given time. The list of defensive stocks includes General Mills (NYSE: GIS) and Johnson and Johnson (NYSE: JNJ).
less than twice their book value per share
Page 47 of 247 Value stocks appear inexpensive when compared to their corporate earnings, dividends, sales or other fundamental factors. Basically, you're getting more than what you pay for: a good value. When investors are high on growth stocks, value stocks tend to be ignored, making them even better bargains for savvy investors. Value investors believe that these stocks make the best buys given their reasonable price in relation to many growth stocks. Of course, a good value is highly dependent on current stock prices, so a good value today may not be a good value next month. A good rule of thumb is to look for solid companies that are trading at l___s-t___n-t____e t____r b___k v____e p_r s____e. An example of a good value (at least as of May 2009) is NYSE Euronext (yes, that's the stock exchange itself), with a price to book value ratio of 0.94.
redemption date and a fixed dividend that gets paid regardless of the company's earnings
Preferred stocks have almost as much in common with bonds as they do with common stocks. Essentially, this type of stock comes with a r__________m d____e a_d _ f____d d_______d t____t g__s p____d r_________s o_ t_e c_______'_ e_______s. If the corporation has financial difficulties, holders of preferred stock have priority when it comes to dividend payments. In times of prosperity, some preferred shares (called "participating preferred") may get a second dividend payout that is based on earnings. As the owner of preferred stock, you normally don't have the rights that come with common stock ownership (like voting). However, preferred stock can be a good portfolio addition for income-oriented investors.
Until you understand exactly what the company does and how well it does it, it would be wise to postpone your investment decision
Page 35 *Buying stock in a company* Getting a piece of the action Purchasing shares of stock is like buying a business. That's the way Warren Buffett, one of the world's most successful investors, views it and his philosophy is certainly worth noting. When you buy stock, you're actually buying a portion of a corporation. If you wouldn't want to own the entire company, you should think twice before you consider buying even a piece of it. If you think of investing in these terms, you will probably be a lot more cautious when singling out a single company. It's important to become acquainted with all of the details of the company you are considering. What products and services does the company offer? Which part of the business accounts for the greatest revenue? Which part of the business accounts for the least revenue? Is the company too diversified? Who are its competitors? Is there a demand for the company's offerings? Is the company an industry leader? Are any mergers and acquisitions in the works? U____l y_u u________d e_____y w__t t_e c______y d___s a_d h_w w__l i_ d___s i_, i_ w____d b_ w___e t_ p______e y___r i__________t d_______n.
To calculate market capitalization, multiply the current market price of a stock by the number of outstanding shares
Page 37 Corporations come in all sizes. You can invest in a wildly successful mega-cap company or a microcap company that is just beginning to show signs of growth potential. Some people prefer to buy the common stock of well-established companies whilst other investors would rather invest in smaller, growth-oriented companies. No matter what type of company fits with your overall strategy, it's important to research every potential stock that you buy. Just because the company has been around for decades doesn't mean it's the best investment vehicle for you. Furthermore, companies are always changing and it's important to make sure that the information you are reviewing is current. Mergers and acquisitions have become commonplace and it's essential to know if a company you are considering buying is undergoing, or is planning to undergo such a transaction. Find out a companies market capitalization, or the market value of all of the company's outstanding shares. T_ c_______e m____t c_________n, m_____y t_e c______t m_____t p____e o_ _ s____k b_ t_e n_____r o_ o______g s_____s. The number of outstanding shares refers to the number of shares that have been sold to the public
Common stocks are equity securities that are sold to the public and each share constitutes ownership in a corporation
Page 37 Types of stocks C_____n s_____s a_e e______y s________s t___t a_e s___d t_ t_e p____c a_d e____h s_____e c________s o_______p i_ _ c________n, when people talk about trading shares, they are talking about common stocks. Preferred stocks are somewhat different; while they still do not constitute ownership in a corporation, they also have some characteristics that are more in common with bonds than they have with common stocks.
Start your investing career by looking at companies with at least 5 million shares outstanding, this indicates that the stock is heavily traded, which means that there will be a ready market for it should you decide to sell your shares
Page 41 Dividends Reaping the profits Dividends are payments to shareholders that are not based on the stock price but are made simply because the company has reached healthy profits and chooses to reward its shareholders. Depending on the company's profits, the Board of Directors will decide whether and how often to pay dividends to shareholders. Dividends are usually most important to investors looking for income in stocks that pay dividends are therefore known as income stocks. Many companies pay dividends on a quarterly basis and special one-time dividends may also be paid under certain circumstances. The term "shares outstanding" refers to the number of shares that a company has issued to the general public, including its employees. It's a good idea to s____t y___r i______g c____r b_ l______g a_ c_____s w__h a_ l____t _ m_____n s____s o_______g. T__s i_______s t__t t_e s___k i_ h_____y t____d, w___h m___s t___t t____e w__l b_ _ r____y m____t f_r i_ s____d y_u d____e t_ s__l y___r s____s. At the same time, more shares outstanding can mean smaller dividends per shareholder (there's only so much money to go around, after all), so keep that in mind when you are looking for steady income.
Shrinking dividends may indicate plans for expansion; when a company's primary goal is growth, dividends may be smaller
Page 42 To be entitled to dividends, you must actually own the shares on the record date, which is the day that the Board of Directors declare a dividend. Compare the current dividend with the dividends paid over the past five years. S_______g d_______s m_y i_______e p____s f_r e_______n; w___n _ c______'_ p______y g____l i_ g_____h, d________s m_y b_ s______r.
Large-cap: $10 billion and over; mid-cap: between $2-10 billion; small-cap: between $300 million and $2 billion; micro-cap: under $300 million
Page 45 of 247 Small-, mid-, and large-Stocks A publicly-traded corporation that has 30 million shares outstanding that are currently trading for $20 each would have a market capitalization of $600 million. Although there are a few different groupings used to categorize stocks by their capitalization, here is a general rule of thumb you can follow: L____e-c_p: $1_ b____n a_d o__r M_d-c_p: b____n $2-$1_ b_____n S___l c_p: b____. $3_0 m____n a_d $_ b____n M_____p: u___r $3_0 m____n The small-cap stock category includes many of the small emerging companies that have survived their initial growing pains and are now enjoying strong earning gains along with expanding sales and profits. Today's small-cap stocks may be tomorrow's leader; it can also be tomorrow's loser. Overall, such stocks tend to be *very volatile and risky*. A safe way of adding these to your portfolio can be through a professionally-managed small-cap fund. That way, you will have exposure to potentially explosive profits *without the added risk* of investing in a *particular* company. Mid-cap stocks, as the name suggests, are bigger than small caps smaller than large caps. Large-cap stocks are the biggest players in the stock market. A large-cap corporation typically has a more solidly-established presence and more reliable sales and profits that smaller corporations. Most of the time, larger companies make less risky investments than smaller companies; the trade off, however, is slower growth rates. Most investors hold large-cap stocks for the long term and for good reason: more than 50 years of historical market returns show that these corporate giants yield only slightly lower returns and short term investments, with much less volatility.
To calculate total returns, add the stock price change (or subtract it if the price has gone down) and dividends for the past 12 months and then divide by the price at the beginning of the 12 month period
Total return Most investors in stocks tend to think about their gains and losses in terms of price changes, not dividends, whereas those who own bonds pay attention to interest yield and seldom focus on price changes. Both approaches are incomplete. Although dividend yield may be more important if you are seeking income, and price changes take center stage for growth stocks, the total return on any stock investment is extremely important. Knowing a stock total return Page 41 makes it possible for you to compare your stock investments with other types of investments, such as corporate or municipal bonds, treasuries, mutual funds and unit investment trusts. T_ c_____e t___l r_____s, a__d t_e s___k p____e c____e (o_ s_____t i_ i_ t_e p___e h_s g___e d___n) a_d d______s f_r t_e p___t 1__ m____s a_d t___n d____e b_ t_e p___e a_ t_e b______g o_ t_e 1_ p____d. For example, suppose that you buy a stock at $45 per share and you receive $1.50 in dividends for the next 12 month period. At the end of the period, the stock is selling and $48 per share. Your calculations would look like this: Dividend: $1.50 Price change: up $3.00 per share $1.50 + $3.00 per share = $4.50 $4.50 divided by $45 = .10 Your total return is a 10% increase. But, suppose, instead, that the price had dropped to $44 per share by the end of the period. Then your calculations would look like this: Dividend: $1.50 Price change: down $1.00 per share $1.50 - $1.00 per share equals $.50 $.50 divided by $45 = .011 Your total return is only a 1.1% increase
