Download LO#3

LO#3
Learning Objective # 3
Explain how you can evaluate
stock investments.
LO#3
Stock Valuation
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Important to understand different approaches used
by experts to analyze stocks
Fundamental Analysis
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Technical Analysis
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A way to value stocks by looking at micro and macro
factors that might influence the economic value of stocks
The idea that changes in investor sentiment are responsible
for changes in trends, and that the value of a stock can be
predicted by extrapolating price from historical patterns
Efficient Market Hypothesis
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States that future prices cannot be predicted from past
trends and patterns
LO#3
Classification of Stock Investments
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Blue chip stock
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Income stock
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Safe investment in strong and respected companies
Attracts conservative investors
ex. Bell Canada, Royal Bank
Pays higher than average dividends, ex. utility stock
Growth stock
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Earns above average profits of all firms in the economy.
Less than 30% of earnings are paid out as dividends, with
rest reinvested in research & development
ex. Southwest Airlines, Home Depot
LO#3
Classification of Stock Investments
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Cyclical stock
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Follows the business cycle of advances and
declines in the economy
ex. automobiles, timber, and steel
Defensive stock
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Remains stable during declines in the
economy
ex. Kellogg, Procter & Gamble and utility
stocks
LO#3
Classification of Stock Investments
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Large cap stocks
 Issued by a large corporation that has a large
amount of stock outstanding & a large amount of
capitalization
Capitalization
 The total amount of securities--stocks and bonds-issued by a corporation
Small cap stocks
 Issued by a company that has a capitalization of
$150 million or less
Penny Stocks
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Typically sell for less than $1 per share
LO#3
Sources of Information on Stocks
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Newspapers
The Internet
Stock Advisory Services
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Charge a fee
Hundreds to choose from
Corporate News
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Disclose information about corporate earnings, assets
and liabilities, products or services
LO#3
Factors that Influence the Price of Stocks
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Bull market
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Investors are optimistic about nation’s economy
More investors are buying stock and the stock
market increases
Bear market
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Investors are pessimistic about economy
More investors are selling stock so and the stock
market declines
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Return
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Annual Shareholder’s Return
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A stock’s annual dividend and increase in value divided
by its beginning-of-year stock price
Annual Shareholder = Annual Dividend + Appreciation in Value
Return
Initial Stock Investment
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Return
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Dividend Yield
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A stock’s annual dividend divided by its beginning-ofyear stock price
If the dividend is divided by the end-of-year stock
price, it is referred to as its trailing dividend yield
Annual Dividend Yield = Annual Dividend
Initial Stock Investment
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Returns
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Capital Gains Yield
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A stock’s increase in value divided by its beginning-ofyear stock price
Capital Gains Yield = Appreciation in Value
Initial Stock Investment
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Returns
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Earnings Per Share
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Are the corporation’s after tax-earnings divided by the
number of outstanding shares of common stock
Earnings Per Share =
After-Tax Earnings
Number of outstanding shares
of common stock
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Returns
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Price-Earnings (PE) Ratio
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Price of one share of stock divided by the earnings per
share of stock over the past 12 months
A low price-earnings ratio means a stock could be a
good investment
Price-Earnings Ratio =
Price Per Share
Earnings per share of stock
Outstanding over the last 12 months
LO#3
Measures of Corporate Risk, Performance and
Shareholder’s Returns
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Beta
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Is an index that compares the risk associated with a
specific stock issue with the risk of the stock market in
general