Download Stocks

Chapter 9
Section 9.2 – Evaluation of a
Stock Issue
 Stocks
are classified into the following
categories:
1. Blue-Chip Stock
2. Income Stock
3. Growth Stock
4. Cyclical Stock
5. Defensive Stock
6. Large Cap Stock and Small Cap Stock
7. Penny Stocks
 Blue
Chip Stocks – considered a safe
investment that generally attracts
conservative investors
• Issued by the strongest and most respected
companies
 AT&T, General Electric, and Kellogg
• Look for leadership in an industry, a history of
stable earnings, and consistency in the payment
of dividends
 Income
stock – pays higher than
average dividends compared to other
stock issues
• People who buy preferred stock are also
attracted to this type of stock
• Examples: Bristol-Myers Squibb and Dow
Chemical and gas and electric companies
 Growth
stock – issued by a corporation
whose potential earnings may be higher
than the average earnings predicted for all
the firms in the country
• Generally don’t pay dividends
• Look for signs that the company is engaged in
activities that produce higher earnings and
revenues:
 Building new facilities; introducing new, high quality
products; or conducting recognized research and
development
• In the early 2000s included Home Depot and
Southwest Airlines
 Cyclical
stock – has a market value that
tends to reflect the state of the economy
• When the economy is improving the market
value of cyclical stock usually goes up and if the
economy is declining then it tends to go down
 Why? Because the companies are linked directly with
activities of a strong economy.
• Investors buy when right before the economy
improves and sell right before the economy
starts to decline
• Ford and Centex are considered cyclical stocks
 Defensive
stock – a stock that remains
stable during declines in the economy
• Companies that issue defensive stocks have
steady earnings and can continue to pay
dividends
• Many blue chip stocks and income stocks may
also be considered defensive stocks
 Proctor & Gamble and Kellogg
 Large
cap and small cap stocks –
• Large cap stock – the stock of a corporation that
has issued a large number of shares of stock and
has a large amount of capitalization (the total
amount of stocks and bonds issued by a
corporation)
 Stocks listed in the Dow Jones averages are typically
large cap stocks
 These stocks appeal to conservative investors
because they are considered secure
 Large
cap and small cap stocks –
• Small cap stocks – issued by a company with a
capitalization of $150 million or less
 Considered higher investment risk because smaller,
less established companies issue this type of stock
 Penny
stock – typically sells for less than
$1 a share, although it can sell for as
much as $10 a share
• Issued by new companies or companies whose
sales are very unsteady
• Prices of penny stocks can go up and down
wildly
• Hard to keep up with performance because the
information is hard to find
• Very risky and should be purchased only by
investors who understand all the risks
 Financial
section of newspapers
 Internet
 Stock
Advisory Services
 Corporate News Publications
 When
you are deciding whether to buy
or sell stock you must first consider the
overall condition of the stock market:
• Bull market – a market condition that occurs
when investors are optimistic about the economy
and buy stocks
• Bear market – a market condition that occurs
when investors are pessimistic about the
economy and sell stocks
 Numerical
Measures for a Corporation
• One of the most common calculations investors
use to track the value of their investments is the
current yield (the annual dividend divided by
the investment’s current market value)
 Generally, an increase in current yield is a healthy
sign for any investment
 Numerical
Measures for a Corporation
continued
• Also need to know whether your investment is
increasing or decreasing in dollar value…Total
return is a calculation that includes the annual
dividend as well as any increase or decrease in the
original purchase price of the investment
 Total Return = Current Return + Capital Gain
 Current Return = Dividend x Number of Shares x Years
held
 Capital Gain = (Selling Price Per Share – Purchase Price
Per Share) x Number of Shares held
 Numerical
Measures for a Corporation
continued
• Earnings per share are a corporation’s net, or
after tax earnings divided by the number of
outstanding shares of common stock. This
measures the amount of corporate profit that can
be assigned to each share of common stock.
 Gives a stockholder an idea of how profitable the
company is…an increase in earnings per share is a
good sign for any investment.

Numerical Measures for a Corporation continued
• Price-earnings (PE) ratio – the price of one share of
stock divided by the corporation’s earnings per share of
stock outstanding over the last 12 months
 Used to compare corporate earnings to the market price of a
corporation’s stock
 Key factor that serious investors as well as beginners can use
to decide to invest in stock
 A low PE ratio indicates that a stock may be a good investment; the
company has a lot of earnings compared to the price of the stock
 A high PE ratio indicates that a stock may not be a good investment; the
company has little earnings compared to the price of the stock
 Although PE ratios vary by industry, they range between 5
and 35 for most corporations
 Fundamental
theory – assumes that a
stock’s real value is determined by
looking at the company’s future earnings
 Technical theory – based on the idea that
a stock’s value is really determined by
forces in the stock market itself
 Efficient market theory – stock price
movements are purely random