Transcript lec03 - BCCBUSINESSSTUDIES

LECTURE 3:
BASICS OF INVESTING II
Economics 98/198 Decal
Spring 2008
Today’s Schedule
 Lecture Content
 Basics of Investing
 Market capitalization
 Earning reports
 Stocks splits / stock buybacks
 Investing on Margin
 Short-selling
 Industries / Sectors
 Current Events
 Assigned Reading / Next Week
Lecture Content
Market Capitalization
Market Capitalization
 Also known as “market cap”
 Refers to the value of ALL company outstanding
shares (shares owned by investors)
 Useful for gauging a company’s size and therefore,
some of the risk characteristics associated
Market Cap =
Stock Price
X
# of shares outstanding
(stock held by investors, officers, & insiders)
Market Capitalization: Example
 Example. Amazing DeCal Cookies Co., Ltd.
 Share Price $20
 Shares Outstanding: 50,000,000 shares
 Market cap?
 Example. Berkeley Traders Co., Ltd.
 Share Price $100
 Shares Outstanding: 1,000,000 shares
 Market Cap?
Different Capitalizations
 Not exact, but general guidelines for size categories
 Large Cap
 Companies with $10b - $200b market cap
 Often referred to as “blue-chip” stocks (low volatility, dividends)
 “Mega-Cap” - $200b+ (HUGE)
 Mid Cap
 Companies with $2b - $10b market cap
 Small Cap
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Companies with $300m - $2b market cap
Typically newer, relatively younger companies
Can present potential for greater capital gains, but at greater risk
“Micro-cap” - $50m-$300m market cap – VERY SMALL
Market Capitalization Perspective
Large Cap
 Microsoft (Nasdaq: MSFT) $264 billion
 Wal-Mart (NYSE: WMT) $201 billion
 Coca-Cola (NYSE: KO) $138 billion
 Walt Disney (NYSE: DIS) $60 billion
 Yahoo! (Nasdaq: YHOO) $39.5 billion
Small/Mid - Cap
 Logitech International (Nasdaq: LOGI) $5 billion
 J Crew Group Inc. (NYSE: JCG) $2.6 billion
 Barnes & Noble (NYSE: BKS) $1.9 billion
 Papa Johns (PZZA) $694 million
 TradeStation Group (TRAD) $471 million
Source: Google Finance as of 2/12/2008 closing prices
Comparing Small and Large Caps
(S&P 500 vs. S&P 600) – last decade
Black line = S&P 500
Large Caps
Orange line = S&P 600
Small Caps
Comparing Small and Large Caps
(S&P500 vs. S&P 600) – Past 2 Years
Black line = S&P500
Orange line = S&P 600
Stock Splits
Stock Buybacks
Stock Splits
 When a company divides the number of its
existing stocks into multiple shares
 In 2-for-1 split, each stockholder gets an
additional share for each share he or she
holds
 Also, value of each share is reduced in half:
2 shares now equal original value of 1 share
before split (total value not changed)
Stock Splits
If you still don’t get it, think of it this way..
 If you have a $100 bill, and I exchange with you two
$50 bills
 How many bills do you have?
 What is the total value of money you have?
Stock Splits
 Why do companies do this?
 Brings the share price down to a more “attractive”
level for smaller investors (purely psychological)
 Can potentially result in price increase because these small
investors will be more likely to buy the stock
 Some also say stock split will increase price because it is a
signal of strong growth
 Increases stock’s liquidity (What is liquidity?)
Stock Splits
 Effects
 Excessive stock splits may hurt a stock’s price
 Pros and shrewd traders sometimes use excitement
generated by oversized or excessive split as an opportunity
to sell and take their profits
 Oversized splits create substantially larger supply
Stock Buybacks
 When a company buys back its own shares in the
market place
 Also known as “share repurchase”
 Why do it?
 Management believes its stock value is discounted too
steeply (its too cheap)
 Management has confidence in the company and
want to send a message the market
Stock Buybacks
 # of shares outstanding go down as these shares are
bought by the company
 Major impact is that it affects important financial
ratios (ROA, ROE, P/E, EPS)
 What do these ratios mean?
 Briefly, we use them to value or analyze a company
 We’ll discuss this more later
 Are they good or bad?
 Not definitive answer, depends on the situation
Investing on Margin / Short Selling
Investing on Margin
 Borrowing money from brokerages to invest
 Generally, maximum 50% of a purchase can be on
margin (borrowed money)
 However, when borrow money, have to pay an
interest rate on money borrowed
 Ex. I borrow $10,000 and broker charges 5% rate. I have to
pay $500 (10,00 x 0.05) to borrow that money.
Investing on Margin
 PROS
 Potential to get greater profits than investing
with only cash because you profit from money
you don’t have
 CONS
 Works against you when you lose money – can
get really ugly with losses
 Charged interest for money you borrow
Margin Example
Joe buys 100 shares priced at $50 of Smart Inc.
(SMRT) and is allowed to buy another 100 shares
on margin at 10% interest.
100 shares @ $50 (cash)
+$5,000
100 shares @ $50 (margin)
+$5,000
--------------------------------------------------Total Investment
$10,000
(200 shares @ $50)
Margin Example continued
SMRT goes through the roof and increases 100% in 10
months to $100. Joe smartly sells and takes profits.
SMRT Investment (200sh@$100)
Money borrowed from brokerage
Interest on borrowed money
Original Investment
+$20,000
-$5,000
-$500
-$5,000
-------------------------------------------------------------------
Profit
% Return ($9,500/$5,000)
vs. % Return (cash investment only)
$9,500
190%
100%
Homework
 Research companies that you might be interested in
purchasing tomorrow. As well as some of your current
holding that you might be willing to sell tomorrow.
 Remember you have to hold at least 4 stocks each week.
You are not required to sell or buy however every
other week there must be one trade.
 Week 2 READINGS are on my web site
 Quiz December 8 if you read you will have no trouble with the quiz.
 https://bccbusinessstudies.wikispaces.com/
 Vocab Quiz (15 Minutes) tomorrow in Dean’s
computer lab. Weeks 1-4.
Rubric
 Organization
 Research/Effort
 Grammar/Flow
 Vocabulary/Concepts
 Believability
Shorting Stocks
 Betting a stock will go down and attempting to
profit from that downward movement
1.
You essentially “borrow” shares from another
investor (account must be able to trade on margin)
2. You sell those shares at the market price
3. You then wait and root for the stock price to tumble
4. Then you cash out, whether at a profit of loss
5. You then buy the shares at the new market price
and return the shares to their owner
Shorting Example
Scenario 1
Mr. Giant shorts 1000 shares of FORD Co. at $20 a
share – his account gets credited with $20,000
FORD Co. stock plummets to $10 a share
Borrowed and sold short 1000 shares at $20
+$20,000
Bought back and returned 1000 shares at $10
-$10,000
----------------------------------------------------------------------------Profit
+$10,000
% Gain
100%
Shorting Example
Scenario 2
Mr. Giant shorts 1000 shares of FORD Co. at $20 a
share – his account gets credited with $20,000
FORD Co. stock skyrockets to $60 a share
Borrowed and sold short 1000 shares at $20
+$20,000
Bought back and returned 1000 shares at $60
-$60,000
----------------------------------------------------------------------------Profit
-$40,000
% Loss
-200%
Different types of Orders
 Market Order (Buy at Sell at the Market)
 Limit Order
 Order executes to buy / sell at specified price of better
(lower). Limit orders usually cost more, but useful for
getting specified price.
 Trying to get a better entry or exit price.
 Stop Order
 Order executes when the price surpasses a particular point,
which helps buy or sell at a particular price.
 Trying limiting loss or locking profits
Different Types of Orders
 Stop Limit Order
 Executed at a specified price (or better) after a given stop price has
been reached. Order becomes then a limit order to buy (or sell) at
the limit price or better
 Precision purposes
 Good Until Cancelled (GTC)
 An order to buy or sell a security at a set price that is active until the
investor decides to cancel it or the trade is executed. If an order does
not have a good-'til-canceled instruction then the order will expire at
the end of the trading day the order was placed.
 Good Until End of Day
Sector / Industries
Cyclical vs. Non-Cyclical
Sector vs Industry
 Often used interchangeably, but actually mean slightly
different things
 Sectors are the general segments in the economy within
which large groups of companies can be categorized into
 About a dozen sectors in the economy
 Example. Financial Sector, Technology, Basic Materials
 Industry describes a much more specific grouping of
companies with highly similar business activities
 Break down sectors into much more defined groups
 Can be small, but also very large in numbers
 Example. Financial Sector  Asset Management, Insurance,
Banks, etc.
Sector vs. Industries
 Top sectors / industries rotate every cycle
 Important to know which sectors / industries are leading
the market and performing well
 Why? Let’s think back to 1998
 Technology, software, telecom: leading industries then
 If you invested in a company in those industries , the price
would have likely made a solid, if not major, price increase
 Stock prices of companies in the same / similar
industry usually (not always) move in a similar fashion
 CORRELATION! Pay attention to competitors!
Recent Industry Performance
(http://stockcharts.com/charts/performance/Industry1.html)
Cyclical Stocks / Industries
 The term refers to how correlated a company’s
price (or industry) is relative to economic
fluctuations (general economy)
 Non-cyclical stocks (also called defensive stocks)
refer to companies not as susceptible to economic
fluctuations
 Example. Household durables, tobacco, utilities
(Things people buy regardless of the economy)
 These are often goods that necessities rather than
luxuries
Cyclical vs. Non-Cyclical Stocks
 Ford = Blue
Red – Florida Public Utilities
Summary
 Market Capitalization
 Small caps vs. large caps
 Stock Splits
 Stock Buybacks
 Earning Reports
 Shorting Stocks
 Margin
 Industries vs. Sectors
 Cyclical Stocks / Industries
Homework
 1. Read the Finance readings from the website
 Interest rates, margin and master your mindset.
 2. Monitor your stocks over the long weekend.
 3. INDIVIDUALLY: Type 1-2 paragraphs about 1
news event from 1 of the stocks in your portfolio.
 Why is this news important to the stock?
 How will this affect the stock price? How did investors
react?
 If you were the CEO of the company are there any
actions that would need to be taken?
Homework Continued
 4. In YOUR OWN WORDS typed define the following terms in
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complete sentences:
Market Capitalization
Small caps
large caps
Stock Splits
Stock Buyback
Earnings Report
Shorting Stock
Margin
Industries
Sectors
Cyclical Stock
Brokerage
TOMORROW
 MIDTERM WEDNESDAY DECEMBER 16
Accounting Basics Chapter 18 from text.
First 3 Power Point Presentations from Website
 Quiz December 16 on readings from website