Common Stock Basics

1. Definition: Stocks are A type of security that signifies ownership

in a corporation and represents a claim on part of the corporation's
assets and earnings.
2. Types: Common Stock (usually entitles the owner to vote at
shareholders' meetings and to receive dividends). Preferred
(generally does not have voting rights, but has a higher claim on
assets and earnings than the common shares). Class A:
A classification of common stock that may be accompanied by
more voting rights. Class B: a classification of common stock that
usually does not have as many or may not have any voting rights to
elect officers to the Board of Directors of a Corporation.
3. Represents OWNERSHIP in the Corporation.
 Common Stock Basics
4. Owners are also referred to as shareholders or equity owners.
5. Street name: A brokerage account where the customer's
securities and assets are held in the name of the brokerage firm,
rather than you holding the stock certificate yourself. The customer
is still listed as the real or beneficial owner.
6. Board of Directors: A group of individuals that are elected as, or
elected to act as, representatives of the stockholders to establish
corporate management related policies and to make decisions on
major company issues. Such issues include the hiring/firing of
executives, dividend policies, options policies and executive
compensation. Every public company must have a Board of
Directors.
 Valuation of Common Stock
2. Capital Asset Pricing Model

A model that describes the relationship between risk and expected return and that is
used in the pricing of risky securities.

The CAPM says that the expected return of a security or a portfolio equals the rate on a
risk-free security plus a risk premium. If this expected return does not meet or beat the
required return, then the investment should not be undertaken. The security market line
plots the results of the CAPM for all different risks (betas).
 The Panic of 1987
Index arbitrage and portfolio insurance (programmed
trading) were the major cause. From Tuesday 10/13/87 to
10/19/87, the DJIA fell 769 points or 31%. On 10/19/87 the
DJIA fell508 points or 22.6%. On 10/28/29 the DJIA fell 11.7%.

Mutual funds and pension funds use portfolio insurance.

Portfolio insurance is a strategy that uses computer based
models to determine an optimal stock/cash ratio at various
market prices. Two insurance users called for sales equaling
50% in response to a 10% decline in the S&P 500 Index.
 Stock Market Basics
Most stocks are traded on exchanges, which are places where buyers
and sellers meet and decide on a price. Some exchanges are physical
locations where transactions are carried out on a trading floor.
The purpose of a stock market is to facilitate the exchange of securities
between buyers and sellers, reducing the risks of investing.
 Stock Market Basics
Types of Markets
The primary market is where securities are created (by means of an IPO)
while, in the secondary market, investors trade previously-issued
securities without the involvement of the issuing-companies. The
secondary market is what people are referring to when they talk about the
stock market. It is important to understand that the trading of a
company's stock does not directly involve that company.
The most prestigious exchange in the world is the New York Stock
Exchange (NYSE). The "Big Board" was founded over 200 years
ago in 1792 with the signing of the Buttonwood Agreement by 24
New York City stockbrokers and merchants. Currently the NYSE,
with stocks like General Electric, McDonald's, Citigroup, Coca-
Cola, Gillette and Wal-mart, is the market of choice for the largest
companies in America.
 Stock Market Basics
the OTC and Nasdaq

The second type of exchange is the virtual sort

called an over-the-counter (OTC) market, of which
the Nasdaq is the most popular. These markets
have no central location or floor brokers
whatsoever. Trading is done through a computer
and telecommunications network of dealers. It
used to be that the largest companies were listed
only on the NYSE while all other second tier stocks
traded on the other exchanges. The tech boom of
the late '90s changed all this; now the Nasdaq is
home to several big technology companies such
as Microsoft, Cisco, Intel, Dell and Oracle.
 Stock Market Basics
the AMEX

The third-largest stock exchange by trading

volume in the United States. The AMEX is located
in New York City and handles about 10% of all
securities traded in the U.S.
The AMEX has now merged with the Nasdaq. It
was known as the "curb exchange" until 1921.
It used to be a strong competitor to the New York
Stock Exchange, but that role has since been filled
by the Nasdaq. Today, almost all trading on the
AMEX is in small-cap stocks, exchange-traded
funds and derivatives.
 Stock Market Basics
Reading Stock Quotes

Columns 1 & 2: 52-Week High and Low - These are the highest and lowest prices at which
a stock has traded over the previous 52 weeks (one year). This typically does not include
the previous day's trading.

Column 3: Company Name & Type of Stock - This column lists the name of the company.
If there are no special symbols or letters following the name, it is common stock.
Different symbols imply different classes of shares. For example, "pf" means the shares
are preferred stock.

Column 4: Ticker Symbol - This is the unique alphabetic name which identifies the stock.
If you watch financial TV, you have seen the ticker tape move across the screen, quoting
the latest prices alongside this symbol. If you are looking for stock quotes online, you
always search for a company by the ticker symbol. If you don't know what a particular
company's ticker is you can search for it at: http://finance.yahoo.com/.
 Stock Market Basics
Reading Stock Quotes

Column 5: Dividend Per Share - This indicates the annual dividend payment per share. If this space is
blank, the company does not currently pay out dividends.

Column 6: Dividend Yield - The percentage return on the dividend. Calculated as annual dividends per
share divided by price per share.

Column 7: Price/Earnings Ratio - This is calculated by dividing the current stock price by earnings per
share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial.
Column 8: Trading Volume - This figure shows the total number of shares traded for the day, listed in
hundreds. To get the actual number traded, add "00" to the end of the number listed.

Column 9 & 10: Day High and Low - This indicates the price range at which the stock has traded at
throughout the day. In other words, these are the maximum and the minimum prices that people have
paid for the stock.
 Stock Market Basics
Reading Stock Quotes

Column 12: Net Change - This is the dollar value change in the stock price
from the previous day's closing price. When you hear about a stock being
"up for the day," it means the net change was positive.

Quotes on the Internet

Nowadays, it's far more convenient for most to get stock quotes off the
Internet. This method is superior because most sites update throughout the
day and give you more information, news, charting, research, etc.
 Stock Market Basics
Animals in the
Market
The use of  "bull" and "bear" to describe markets comes from the
way in which each animal attacks its opponents. That is, a
bull thrusts its horns up into the air, and a bear swipes
its paws down. These actions are metaphors for the movement of a
market: if the trend is up, it is considered a bull market. And if the
trend is down, it is considered a bear market.

The Bull market is when everything in the economy is great, people

are finding jobs, gross domestic product (GDP) is growing, and
stocks are rising. Things are just plain rosy! Picking stocks during a
bull market is easier because everything is going up. Bull markets
cannot last forever though, and sometimes they can lead to
dangerous situations if stocks become overvalued. If a person is
optimistic and believes that stocks will go up, he or she is called a
"bull" and is said to have a "bullish outlook".
 Stock Market Basics
Bear Markets

Bear Markets characterize the attitude of investors

who believes that a particular security or market
is headed downward. Bears attempt to profit from
a decline in prices. Bears are generally pessimistic
about the state of a given market. Bearish
sentiment can be applied to all types of markets
including commodity markets, stock markets
and the bond market.

 
 
 Stock Market Basics
Selling Short

The selling of a security that the seller does not

own, or any sale that is completed by the delivery
of a security borrowed by the seller. Short sellers
assume that they will be able to buy the stock at a
lower amount than the price at which they sold
short.
Selling short is the opposite of going long. That is,
short sellers make money if the stock goes down
in price.
This is an advanced trading strategy with many
unique risks and pitfalls. Novice investors are
advised to avoid short sales.
Investing in Equities

Common Stock
Investments
 Graham’s Fundamental
Investment Rules
• 1. Adequate Size
• 2. Sufficient Strong Financial
Condition
• 3. Earnings Stability
• 4. Dividend Record
• 5. Earnings Growth
• 6. Moderate Price/Earnings Ratio
• 7. Moderate Ratio of Price to Assets
 Terms
1. Net Current Assets (NCA)
– Defined as:
Current Assets
- Current Liabilities
- Long-Term Debt
- Preferred Stock
NCA Total

NCAc = NCA/# of Common Shares

 Terms (continued)
• 2. Data Source
– S&P Stock Guide
– Value Line, etc.
• 3. Earnings Per Share (EPS)
• 4. Market Price
• 5. Book Value Per Share
• 6. Dividends Per Share
• 7. Current Ratio
 Terms (continued)

• 8. Total Debt
• 9. Equity
• 10. Growth
1/n
g = [ (1 + RP,-1)(1 + RP,-2) ... (1 + RP,-10)] -1
 The Graham Model

• 1. Group A Criteria
#1: E/P > 2 (AAA Yield)(1 pt.)
E/P > 1.33 (AAA Yield) (1/2 pt.)
#2: P/E < .4 (Avg. P/E in last 3 yrs.) (1 pt.)
P/E < .4 (Avg. P/E in last 10 yrs.) (1/2 pt.)
#3: P/Bk < 2/3 (1 pt.)
P/Bk < 1 (1/2 pt.)
#4: D/P > .67 (AAA Yield) (1 pt.)
D/P > .50 (AAA Yield) (1/2 pt.)
#5: P/NCA < 1 (1 pt.)
P/NCA < 1.33 (1/2 pt.)
 Sir John Mark Templeton
• Sir John’s 16 Rules for Investment
Success:
1. Invest for maximum total real return including taxes and
inflation.
2. Invest. Don’t trade or speculate.
3. Remain flexible and open-minded about types of
investments. No one kind of investment is always best.
4. Buy at a low price. Buy what others are despondently
selling. Then sell what others are despondently buying.
5. Search for bargains among quality stocks.
6. Buy value not market trends or economic value.
7. Diversify. There is safety in numbers.
8. Do your homework. Do not take the word of experts.
Investigate before you invest.
 A. Definition
Technical analysis really just studies supply and demand in a
market in an attempt to determine what direction, or trend, will
continue in the future. In other words, technical analysis
attempts to understand the emotions in the market by
studying the market itself, as opposed to its components. If
you understand the benefits and limitations of technical
analysis, it can give you a new set of tools or skills that will
enable you to be a better trader or investor.

Technical Analysis is the belief that90

important information about future 80
70
stock price movements can be 60

obtained by studying the historical 50

40
price movement. 30
20
10
0
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
 Assumptions
1. The Market Discounts Everything
technical analysis assumes that, at any given time, a stock's
price reflects everything that has or could affect the
company - including fundamental factors. Technical analysts
believe that the company's fundamentals, along with broader
economic factors and market psychology, are all priced into
the stock, removing the need to actually consider these
factors separately. This only leaves the analysis of price
movement, which technical theory views as a product of the
supply and demand for a particular stock in the market.
 Assumptions

2. Price Moves in Trends

In technical analysis, price
movements are believed to follow trends.
This means that after a trend has been
established, the future price movement is
more likely to be in the same direction as
the trend than to be against it. Most
technical trading strategies are based on
this assumption.
 Assumptions
3. History Tends To Repeat Itself

Another important idea in technical analysis is that history

tends to repeat itself, mainly in terms of price movement. The
repetitive nature of price movements is attributed to market
psychology; in other words, market participants tend to
provide a consistent reaction to similar market stimuli over
time. Technical analysis uses chart patterns to analyze
market movements and understand trends. Although many
of these charts have been used for more than 100 years, they
are still believed to be relevant because they illustrate
patterns in price movements that often repeat themselves.
Technical Analysis Assumptions:
• Technical analysts base their buy and sell
decisions on the charts they prepare of recorded
financial data
1. Market value is determined by the interaction of supply
and demand.
2. Supply and demand are governed by numerous factors,
both rational and irrational.
3. Security prices tend to move in trends that persist for an
appreciable length of time, despite minor fluctuations in
the market.
4. Changes in a trend are caused by shifts in supply and
demand.
5. Shifts in supply and demand, no matter why they occur,
can be detected sooner or later in charts of market
transactions
6. Some chart patterns tend to repeat themselves.
 Types of Technical Charts:
• Bar Charts

H
C
Dollar L
Price of
Stock

Trading Days
 Types of Technical Charts:
• Line Charts: a graph of successive day’s
closing prices

Closing
Prices

Trading Days
 B. Approaches to
Technical Analysis
• 1. The Dow Theory
– The Dow theory views the movement of market
prices as occurring in three categories
1. Primary Movements: bull and bear markets
2.Secondary Movements: up and down
movements of stock prices that last for a few
months and are called corrections
3. Daily Movements: meaningless random daily
fluctuations
 B. Approaches to Technical
Analysis (continued)
• 2. Trading Action
– a. Concentrates on minor trading
characteristics in the market
– b. Examples include:
• 1. Monday is the worst day to buy stocks,
Friday is the best.
• 2. If January is a good month for the
market then chances are good a good year
will occur.
B. Approaches to Technical
Analysis (continued)
• 3. Bellwether Stocks
– a. A few major stocks in the market are
consistently highly accurate in
reflecting the current state of the
market.
• IBM
• DuPont
• AT&T
• Exxon
• GM
 Approaches to Technical
Analysis (Continued):
• 4. Relative Strength
– The basic idea behind relative strength
is that some securities will increase
more, relative to the market, in bull
markets and decline less, relative to
the market, in bear markets.
Technicians believe that by investing
in those securities that exhibit relative
strength higher returns can be earned.
 B. Approaches to Technical
Analysis (continued)
• 5. Technical Indicators
– a. Market Volume -- a measure of investor
interest
• 1. STRONG when volume goes up in rising
market or drops during declining market
• 2. WEAK when volume goes up in declining
market or decreases during a rally
B. Approaches to Technical
Analysis (continued)
– Example
• On June 3, 2003
– Advances = 930
– Declines = 691
– Difference = + 239
• On June 11, 2003
– Advances = 651
– Declines = 920
– Difference = -269
– Conclusion: A weak market.
B. Approaches to Technical
Analysis (continued)
– b. Breadth of the Market
• 1. Considers the advances and
declines in the market.
• 2. As long as advances outnumber
declines a strong market exists.
• 3. The spread is used as an
indicator of market strength.
 B. Approaches to Technical
Analysis (continued)
– c. Short Interest -- measures the number of stocks
sold short
• When the level of short interest is high, by historical
standards, then the situation is optimistic.
– d. Odd-Lot Trading: Theory of Contrary Opinion
• If the amount of odd-lot purchases start to exceed odd-lot
sales by a widening margin, it may suggest that
speculation is occurring among small investors. This is
the first signal of an upcoming bear market.
 Review Questions: Section 3
• What are two theoretical ways to determine the value of
Common Stock?
• Net Current Asset in the Graham model is defined as?
• Why do we calculate geometric instead of linear growth
rates?
• The Graham model is a fundamental valuation model?
Explain.
• Define technical analysis.
• What are Bellweather stocks?
• Who was Peter Lynch and what is he primarily known for?
• What are Lynch’s 10 golden rules for investing?