Download 15. Investing in Stocks

Personal Finance
SIXTH EDITION
Chapter 15
Investing in
Stocks
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Chapter Objectives
15.1 Identify the functions of stock exchanges
15.2 Describe how to interpret stock quotations
15.3 Explain how to execute the purchase and sale
of stocks
15.4 Explain how to analyze a stock
15.5 Explain how investing in stocks fits within your
financial plan
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Stock Exchanges (1 of 4)
• Stock exchanges: facilities that allow investors to
purchase or sell existing stocks
• New York Stock Exchange
– Most popular organized exchange in U.S.
– Floor traders: traders at a stock exchange who execute
trades to fulfill orders placed by other investors
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Stock Exchanges (2 of 4)
– Specialists: traders who help to make a market in one
or more stocks by taking the position opposite of orders
placed by clients
– A typical stock transaction on the NYSE is submitted
through a brokerage firm and executed by a specialist
• Other stock exchanges
– American Stock Exchange
– Other regional exchanges in large U.S. cities
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Stock Exchanges (3 of 4)
• Over-the-counter (OTC) market: an electronic
communications network that allows investors to
buy or sell securities
– Market makers: traders who execute trades on the
OTC market and earn commissions in the form of a
bid-ask spread
– Less stringent listing requirements than for NYSE
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Stock Exchanges (4 of 4)
– Electronic Communication Networks (ECN): computer
systems that match up desired purchases and sales of
stocks
 Allow for after-hours trading
 No person needed to perform the exchange
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Stock Quotations (1 of 2)
• Price quotations readily available from the
Internet, stock brokers or financial newspapers
• Provide information about the price of each stock
over the previous day or a recent period
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Stock Quotations (2 of 2)
EXHIBIT 15.1 Example of a Daily Stock Quotation
52-Week
Hi
Lo
Stock (Div.)
Yield (%)
PE
Vol. (100s)
Close
Net Change
62.10
49.40
Zugle ($1.00)
Zugle ($1.00)
14
9000
50.00
+.27
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Purchasing and Selling Stocks (1 of 7)
• Selecting a broker
– Analyst recommendations
 May be overly optimistic
 Must disclose ownership of stocks they recommend
– Individual broker skills
 Information available on the Internet
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Purchasing and Selling Stocks (2 of 7)
– Brokerage commissions
 Discount brokerage firm: a brokerage firm that executes your
desired transactions but does not offer investment advice
 Full-service brokerage firm: a brokerage firm that offers
investment advice and executes transactions
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Financial Planning Online (1 of 5)
• Go to the finance section of Yahoo.com
• Click “Get Quotes” after typing the symbol of a
stock in which you are interested
• This site gives analyst recommendations about a
stock that you specify
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Purchasing and Selling Stocks (3 of 7)
• Placing an order
– Name of the stock
 Ticker symbol: the abbreviated term that is used to identify a
stock for trading purposes
– Buy or Sell—specify what you want to do
– Number of shares
 Round lot: shares bought or sold in multiples of 100
 Odd lot: less than 100 shares of stock
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Purchasing and Selling Stocks (4 of 7)
– Market order or limit order
 Market order: an order to buy or sell a stock at its prevailing
market price
 Limit order: an order to buy or sell a stock only if the price is
within the limits that you specify
– Stop orders
 Stop order: an order to execute a transaction when the stock
price reaches a specified level; a special form of limit order
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Purchasing and Selling Stocks (5 of 7)
– Stop orders
 Buy stop order: an order for a brokerage firm to buy a stock
when the price rises to a specified level
 Sell stop order: an order for a brokerage firm to sell a stock
when the price falls to a specified level
• Placing on order online
– Low commission
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Financial Planning Online (2 of 5)
• Go to http://www.etrade.com
• This Web site provides information that you can
use when making investment decisions. It also
illustrates how you can trade stocks online, which
typically reduces your transaction costs.
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Purchasing and Selling Stocks (6 of 7)
• Buying stock on margin
– On margin: purchasing a stock with a portion of the
funds borrowed from a brokerage firm
– Federal Reserve limits margin to 50 percent
– Margin call: a request from a brokerage firm for the
investor to increase the cash in the account in order to
bring the margin back up to the minimum level
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Purchasing and Selling Stocks (7 of 7)
• Short selling stock
– Short selling (shorting): a process by which investors
sell a stock that they do not own
– Borrow stock from another investor and will have to
return it
– Investor hopefully sells high and buys low (in that
order)
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Analyzing Stocks (1 of 11)
• Technical analysis: the valuation of stocks based
on historical price patterns
• Fundamental analysis: the valuation of stocks
based on an examination of fundamental
characteristics such as revenue or earnings, or
the sensitivity of the firm’s performance to
economic conditions
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Analyzing Stocks (2 of 11)
• Analyzing a firm’s financial condition
– Balance sheet: a financial statement that indicates a
firm’s sources of funds and how it has invested its
funds as of a particular point in time
– Income statement: a financial statement that measures
a firm’s revenues, expenses, and earnings over a
particular period of time
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Analyzing Stocks (3 of 11)
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Analyzing Stocks (4 of 11)
– Accounting fraud
 In the early 2000s many firms used fraudulent financial
statements
 Enron and WorldCom are the most prominent examples
 Motivation for fraud
– Manager compensation
• Analyzing economic conditions
– Economic growth: a measure of growth in a country’s
economy over a particular period
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Analyzing Stocks (5 of 11)
– Gross domestic product (GDP): the total market value
of all products and services produced in a country
– Fiscal policy: the means by which the U.S. government
imposes taxes on individuals and corporations and by
which it spends its money
– Impact of international economies
 One country’s strong economy can improve another’s and the
opposite is also true
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Analyzing Stocks (6 of 11)
– Interest rates
 Stocks perform better when interest rates are low
 Some stocks are more sensitive to interest rates than others
 The Federal Reserve uses monetary policy to influence
interest rates
 Monetary policy – policy established by the Federal Reserve to
adjust the supply of funds in the financial system in order to
influence interest rates
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Analyzing Stocks (7 of 11)
– Inflation: the increase in the general level of prices of
products and services over a specified period
 Consumer price index (CPI): a measure of inflation that
represents prices of consumer products such as groceries,
household products, housing and gasoline
 Producer price index (PPI): a measure of inflation that
represents prices of products used to produce other products,
such as coal, lumber, and metals
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Analyzing Stocks (8 of 11)
EXHIBIT 15.3 Sources of Economic Information
Published Sources
 Federal Reserve Bulletin: provides data on economic conditions, including interest rates, unemployment rates, inflation
rates, and the money supply.
 Federal Reserve District Bank publications: provide information on national and regional economic conditions.
 Survey of Current Business: provides data on various indicators of economic activity, including national income,
production levels, and employment levels.
Online Sources
 Bloomberg (http://www.bloomberg.com): provides reports on interest rates, other economic conditions, and news
announcements about various economic indicators.
 Federal Reserve Meeting Information is also available online at http://www.federalreserve.gov.
 Federal Reserve District Bank publications are also online at http://www.frbsf.org.
 Federal Reserve System (http://www.federalreserve.gov): provides detailed statistics on economic conditions.
 St. Louis Federal Reserve District (http://www.stlouisfed.org): provides updated information about U.S. economic
conditions.
 Survey of Current Business is also online at http://www.bea.gov.
 Yahoo! Finance: provides information and news about economic conditions.
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Financial Planning Online (3 of 5)
• Go to http://www.oecd.org
• Click on: OECD Economic Outlook
• This Web site provides information about
economic conditions that can affect the values of
investments.
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Analyzing Stocks (9 of 11)
• Industry conditions
– Stock prices susceptible to industry conditions
 Industry indicators
• Integrating your analyses
– Analyzing the firm, the economy and the industry
allows assessment of future performance
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Analyzing Stocks (10 of 11)
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Analyzing Stocks (11 of 11)
• Limitations of stock analysis
– Difficulty in forecasting future conditions
– Favorable attributes are reflected in the stock price
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Financial Planning Online (4 of 5)
• Go to http://www.bloomberg.com
• Click on: Market Data
• This Web site provides a summary of recent stock
performance.
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Financial Planning Online (5 of 5)
• Go to the finance section of Yahoo.com
• This Web site provides recent quotations of
indexes that can be used as benchmarks when
assessing your investment portfolio’s
performance. Click on “Charts” to review historical
movements in any specific index
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How Stock Investment Methods Fit
Within Your Financial Plan (1 of 3)
• Key decisions about investing in common stock
for your financial plan are:
– Should you consider buying stock?
– What methods should you use for investing in stocks?
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How Stock Investment Methods Fit
Within Your Financial Plan (2 of 3)
EXHIBIT 15.5 How Stock Investment Methods Fit Within Stephanie Spratt’s Financial Plan
GOALS FOR INVESTING IN STOCK
1. Determine if I could benefit from investing more money in common stock.
2. If I consider investing in stocks, determine how to execute stock transactions.
ANALYSIS
Type of Brokerage Firm
Full-service
Guidance on stock selection; higher commissions charged on transactions.
Discount
No guidance on stock selection; lower commissions charged on transactions.
Type of Order When Purchasing Stock
Market Order
A buy order is executed at the market price.
Limit Order
A buy order is only executed if the price is at or below a price that I may specify.
Buy Stop Order
A buy order is executed if the price rises to a price that I may specify.
Whether to Borrow
Pay with Cash
Need cash to pay for the entire investment. My return will be equal to the return on the
stock itself.
Buying on Margin
Can make investment with less money (by borrowing a portion of the funds needed). My
return will be larger than the return on the stock itself. My return (whether it is a gain or
loss) is more pronounced if I borrow to buy the stock, which increases the risk of my
investment.
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How Stock Investment Methods Fit
Within Your Financial Plan (3 of 3)
EXHIBIT 15.5 How Stock Investment Methods Fit Within Stephanie Spratt’s Financial Plan
DECISION
In the future when I invest in stocks, I will use a discount broker instead of a fullservice broker because I prefer to make my own investment decisions and the
commissions charged by a discount broker are low. I will use only limit orders to
buy stocks, so that I can set the maximum price that I am willing to pay. I will only
invest in a stock if I have sufficient funds to cover the entire investment because
it is a less risky method of executing a stock transaction. Buying on margin
magnifies the return (whether positive or negative) on the stock, and causes the
investment to be more risky than I desire.
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