Term
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Definition
Common stockholders “own” a corporation
-They elect Directors via proxies, who hire CEO |
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Term
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Definition
| Corporate management’s job is to create value for its common shareholders through stock price maximization |
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Term
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Definition
Corporations pay taxes on their profits (35% max. rate), and then can elect to:
-Reinvest profits in the firm,
-Pay some of the after tax profits to the shareholders in the form of dividends,
-Buy back its stock on the open market, and or
-Pay down debt |
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Term
| Why do corporations issue common stock? |
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Definition
Why do corporations issue common stock?
-To raise money, start or expand a business
-To pay for ongoing business expenses
-They don’t have to repay the money
-They don’t have to pay interest
-Dividends are not mandatory
-Stocks are known as “equity” securities, & are higher in risk than preferred stocks or bonds |
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Term
| How Do I Make Money on Stocks? |
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Definition
-From dividends received
+Known as the dividend yield
-From capital gains when you ultimately sell the stock
+Known as the capital gain yield
-The sum of the above is the total return on your investment |
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Term
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Definition
-Income from dividends
-Current dividend yield = current quarterly dividend x 4 divided by current stock price, for example
-$0.50 quarterly dividend and $100 stock price =
$2.00/$100 = 2% yield |
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Term
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Definition
-Most corporations believe there is an ideal stock price range for their stock ($20-$80)
-Fast growing companies with rising stock prices will often “split”, say 2 for 1
+You get twice the shares, price falls in half |
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Term
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Definition
| Total annual return includes dividends plus capital gain (loss) on a stock during the holding period |
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Term
| Geometric vs. Average Annual Returns |
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Definition
| Geometric (or compound average returns) are most meaningful |
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Term
| Preferred stock (a hybrid security with characteristics of both a stock and a bond) |
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Definition
-Receive cash dividends before common stockholders are paid any cash dividends
-The dividend amount is either a stated amount for each share of preferred stock, or a percentage of the par value
-Par value is an assigned dollar value on a certificate
-Callable preferred stock is stock a corporation can be exchanged for a specified amount of money |
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Term
| Features of Preferred Stock |
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Definition
-Cumulative feature
-Unpaid cash dividends accumulate and must be paid before any cash dividends are paid to the common stock holders
-Conversion feature
-Can be traded for shares of common stock
-Risk
-Less than stocks, more than bonds
-Very difficult for the average investor to understand, best to use a mutual fund |
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Term
Common Stocks
Blue chip stock |
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Definition
-Safe investment in strong and respected companies (flight to quality)
-Attracts conservative investors
-ex. General Electric, Walmart |
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Term
Classification of Common Stocks
Income stock |
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Definition
-Pays higher than average dividend yield
-ex. utility stock |
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Term
Classification of Common Stocks
Growth stock |
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Definition
-Earns above average profits of all firms in the economy
-Less than 30% of profits are paid out as dividends, balance reinvested in firm
-Investors realize appreciation in stock price
-ex. Panera Bread, Apple |
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Term
Common Stocks
Value Stocks |
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Definition
-Stocks where the underlying value of the assets is worth more than current trading price
-The sum of the parts is > whole
-Merger value
-Fix up value |
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Term
Classification of Common Stocks
Initial Public Offerings (IPOs) |
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Definition
-Companies issuing shares in the primary market for the first time, typically a highly prized investment (e.g. Google)
-Returns on IPOs Are Not That Good |
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Term
Classification of Common Stocks
Cyclical stock |
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Definition
Follows the business cycle of advances and declines in the economy
-ex. automobiles, chemicals, and steel |
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Term
Classification of Common Stocks
Defensive stock |
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Definition
-Remains stable during declines in the economy
-ex. Kellogg, Procter & Gamble |
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Term
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Definition
| Total capitalization is the value of all securities--stocks and bonds--issued by a corporation |
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Term
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Definition
| Market capitalization is the value of the common stock (current share price times shares outstanding) |
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Term
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Definition
Market cap” definitions vary
-Large cap vs. mid cap vs. small cap – everyone uses their own definition
-Company size impacts risk and growth prospects |
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Term
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Definition
Classification of Common Stocks
-Large cap stocks > $25 billion of market cap
-Mid cap stocks: $2 to $25 billion of market cap
-Small cap stocks: $600 mil to $2 billion market cap
-Micro cap stocks: $50 million to $600 million
-Penny stocks (typically micro caps) |
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Term
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Definition
Foreign Stocks
-Traded on US exchanges as American Depository Receipt (ADR
-EAFE is typical benchmark index
-Experts recommend some percentage of your equity portfolio be in foreign stocks/mutual funds |
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Term
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Definition
| Earnings Per Share (EPS) are the corporation’s after-tax earnings divided by the number of outstanding shares of common stock. Past, current and future earnings prospects drive stock prices! |
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Term
| Price to Earnings (PE) ratio |
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Definition
-Price of one share of stock divided by the earnings per share of stock over the last 12 months
-A low PE ratio means a stock could be a good investment, or a slow growth company
-A high PE ratio implies higher growth, and potentially higher risk |
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Term
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Definition
Betas are used to measure stock risk
-Using statistics, we can correlate the returns of an individual stock or mutual fund against movements in the overall market, and develop a beta
-Perfect correlation = 1 (index fund)
-No correlation = 0 |
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Term
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Definition
-Based on the assumption that a stock’s intrinsic or real value is determined by the company’s future earnings and cash flow
-Fundamentalists consider the…
-Financial strength of the company
-Type of industry company is in
-New-product development
-Economic growth of the overall economy |
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Term
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Definition
Technical theory
-Based on the assumption that a stock’s value is determined by the forces of supply and demand in the stock market as a whole
-Not based on expected earnings or the intrinsic value of a stock but rather on factors found in the market as a whole |
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Term
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Definition
Efficient market theory
-Sometimes called the random walk theory
-A stock’s current market price reflects its true value
-It is impossible for an investor to outperform the average for the stock market as a whole over a period of time – suggests indexing |
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Term
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Definition
-Capital Asset Pricing Model
-Dividend Growth Model
-Black Scholes Option Pricing Model |
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Term
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Definition
Bull market
-Investors are optimistic
-More investors are buying stock and the stock market increases |
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Term
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Definition
Bear market
-Pessimistic views on economy
-More investors are selling stock so and the stock market declines |
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Term
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Definition
| Market risk premium is the additional return investors receive by investing in higher risk stocks vs. risk free investments such as Treasury Bonds. |
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Term
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Definition
Primary market
-A market in which an investor purchases financial securities via an investment bank, or other representative, from the issuer of those securities
-An investment bank is a financial firm that assists corporations in raising fund,s usually by helping to sell new security issues
-An IPO occurs when a corporation sells stock to the general public for the first time |
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Term
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Definition
Secondary market
-A market for existing financial securities that are currently traded among investors (NYSE/Nasdaq) |
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Term
| 1933 Securities Act & 1934 Securities Exchange Act |
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Definition
1933 Securities Act & 1934 Securities Exchange Act
-Requires audited financial statements and disclosures |
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Term
| Account executive (stockbroker) |
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Definition
| An account executive, or stockbroker, is a licensed individual who buys and sells securities for his or her clients |
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Term
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Definition
Churning
-Excessive buying and selling of securities to generate commissions |
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Term
| Discount broker vs. full service brokers |
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Definition
| Commissions for full service brokers are not generally worth the cost, use a discount broker |
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Term
Stock Transactions
On-line transactions |
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Definition
On-line transactions
-Discount brokerage firms and some full services brokerage firms allow investors to trade online |
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Term
Stock Transactions
Commission charges |
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Definition
Commission charges
-Wide range depending on the amount of service
-Round lot is 100 shares or multiples of 100 shares An odd lot is fewer than 100 shares
-Round lots (100/500/1000) will help reduce transaction costs (measured in per share amounts, or as a %) |
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Term
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Definition
| market order is a request to buy or sell stock at the current market value |
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Term
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Definition
| limit order is a request to buy or sell a stock at a specified price or price range |
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Term
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Definition
| stop order is a request to sell a stock at the next available opportunity after its market price reaches a specified amount |
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Term
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Definition
| discretionary order lets the account executive decide when to execute the transaction and at what price |
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Term
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Definition
-Buying on margin (margin calls)
-Selling short (you must pay the dividends)
-Option contracts
-Buy or sell a put (an option to sell a stock at a set price)
-Buy or sell a call (an option to call a stock at a set price) |
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Term
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Definition
Futures contracts
Must have high net worth $500,000+ due to risk |
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Term
| Long-term investment techniques |
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Definition
Long-term techniques
-Buy and hold (for index portfolio)
-Dollar cost average
-Direct investment and dividend investment |
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Term
| Short-term investment techniques |
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Definition
Short-term techniques (not recommended)
-Buying stock on margin (borrowing money)
-Selling short (borrowing stock)
-Trading in options |
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Term
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Definition
-There is a double taxation of dividends
-Corporations pay taxes (35%), then pay dividends from after tax profits
-Individuals must also pay taxes on dividends
-Bush tax cut of 2003 changed dividend tax from “ordinary” rates to a lower rate
-Corporations have since increased dividends |
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Term
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Definition
-“Qualifying” dividends taxed at 15% or lower rates
-REITs and most preferred dividends not “qualifying” (since most PS is really debt)
-Lower rate makes investing in dividend paying stocks much more attractive |
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Term
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Definition
Capital gains and losses (short/long)
Short term gains taxed at ordinary rates
Long term gains > year taxed at lower rates (15% or lower) |
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