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Investment in Equity
Learning Goals
 What is equity market
 What is common stock. and what is Preferred stock
 Type of common stock and Preferred stock
 Strategy and style in investing in common stock
Equity Investment
 Common Stock and Preferred Stock
 2 types of rights
 Voting Right
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Right to vote
Elect management of corporation
 Preemptive Right
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Right to keep proportionate ownership of the company
Let common shareholders buy new shares of stock before
non-stockholders
 Other Rights of Common Stockholders
 Right to inspect the books and records of the company
 Privilege of receiving dividends as cash, stock or
property
 Right to receive distributions of any remaining assets
should the company go out of business
An Overview of Common Stock
 Represents ownership in a corporation
 Known as equity securities or equities representing
ownership shares in a corporation
 Voting right
 No maturity date
 Characteristics of common stock
 Residual claim - claim on the assets of a firm that goes
bankrupt. Receive the assets after all other creditors,
bondholders and preferred shareholders
 Limited Liability – shareholders only lose their amount
of investment and not their personal belongings
Common Stock Dividend
 May be paid in cash, stock or property
 Determines by Board of Directors
 Increases or reductions are depend on how well the
company is performing
 Corporate or Market Factors is one of the factors in
making a decision to pay out dividends
Types of Common Stock Dividend
 Cash Dividends are those that are paid out in cash
form
 Stock Dividends are dividends paid out in the form of
additional stock shares in the corporation, or shares of
a subsidiary corporation
 Property Dividends are paid with assets owned by the
issuing company
Types of Common Stocks
 Blue Chip Stocks: financially strong, high-quality
stocks with long and stable records of earnings and
dividends
 Companies are leaders in their industries
 Relatively lower risk due to financial stability
of company
 Popular with investing public looking for steady growth
potential, perhaps dividend income
 Provide shelter during unsettled markets
 Examples:
 Income Stocks: stocks with long and sustained
records of paying higher-than average dividends
 Good for investors looking for relatively safe and high
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level of current income
Dividends tend to increase over time (unlike interest
payments on bonds)
Some companies pay high dividends because they offer
limited growth potential
More subject to interest rate risk
Examples:
 Growth Stocks: stocks that experience high rates
of growth in operations and earnings
 Have sustained rate of growth in earnings above
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general market
Investors expect higher price appreciation due to
increasing earnings
Riskier investment because price may fall if earnings
growth cannot be maintained
May include blue chip stocks as well as
speculative stocks
Typically pay little or no dividends
Examples:
 Tech Stocks: stocks representing the technology
sector of the market
 Range from speculative stocks of small companies that
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have never shown a profit to blue chip stocks of large
companies that are growth-oriented
Potential for attractive returns
Considerable risk and volatility
Difficult to put value on due to erratic or no earnings
Examples:
 Speculative Stocks: stocks that offer potential for
substantial price appreciation, usually due to some
special situation such as a new product
 Companies lack sustained track record of business and
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financial success
Earnings may be uncertain or highly unstable
Potential for substantial price appreciation
Stock price subject to wide swings up and down
in value
Examples:
 Cyclical Stocks: stocks whose earnings and
overall market performance are closely linked to
the general state of the economy
 Stock price tends to move up and down with the
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business cycle
Tend to do well when economy is growing, especially in
early stages of economic recovery
Tend to do poorly in slowing economy
Best for investors willing to move in and out of market as
economy changes
Examples:
 Defensive Stocks: stocks that tend to hold their
value, and even do well, when the economy starts
to falter
 Stock price remains stable or increases when general
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economy is slowing
Products are staples that people use in good times and
bad times, such as electricity, beverages, foods
and drugs
Gold stocks are a form of defensive stock
Best for aggressive investors looking for “parking place”
during slow economy
Examples:
 Mid-Cap Stocks: medium-sized companies with
market capitalizations between $1 billion and $4 or
$5 billion
 Provide opportunity for greater capital appreciation
than Large-Cap stocks, but less price volatility than
Small-Cap stocks
 Usually have long-term track records for profits and
stock valuation
 “Baby Blues” offer same characteristics of Blue Chip
stocks except size
 Examples:
 Small-Cap Stocks: small companies with market
capitalizations less than $1 billion
 Provide opportunity for above-average returns
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(or losses)
Usually do not have a financial track record
Earnings tend to grow in spurts and can have dramatic
impact on stock price
Usually not widely-traded; liquidity is an issue
“Initial Public Offerings (IPOs)
Examples:
Alternative Investment Strategies
 Buy-and-Hold
 Investors buy high-quality stocks and hold them for
extended time periods
 Goal may be current income and/or
capital gains
 Investors often add to existing stocks over time
 Very conservative approach; value-oriented
 High Income
 Investors buy stocks that have high dividend yields
 Safety of principal and stability of income are
primary goals
 May be preferable to bonds because dividends levels
tend to increase over time
 Often used to provide to supplement other income, such
as in retirement
 Quality Long-Term Growth
 Investors buy high-quality growth stocks, mid-cap
stocks and tech stocks
 Capital gains are primary goal
 Higher level of risk due to emphasis on capital gains
 Significant trading of stocks may occur over time
 Diversification is used to spread risk
 “Total Return Approach” is version that emphasizes both
capital gains and high income
 Aggressive Stock Management
 Investors buy high-quality growth stocks, blue chip
stocks, mid-cap stocks, tech stocks and cyclical stocks
 Capital gains are primary goal
 High level of risk due to emphasis on capital gains
 Investors aggressively trade in and out of stocks, often
holding for short periods
 Timing the market is key element
 Time consuming to manage
 Speculation and Short-Term Trading
 Also called “day trading”
 Investors buy speculative stocks, small-cap stocks and
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tech stocks
Capital gains are primary goal
Highest level of risk due to emphasis on capital gains in
short time period
Investors aggressively trade in and out of stocks, often
holding for extremely short periods
Looking for “big score” on unknown stock
Time consuming & high trading costs
Investment Styles
 Growth Investing
 is investing in stocks with above average forecasts of
earnings growth and high price/earning ratios in
expectation of higher return.
 Investors need to monitor both company’s performance
and industry trend closely, because these stocks are
sensitive to change.
 Riskier than other styles as they rise faster and fall faster.
 Strategies - focus on capital appreciation; quality longterm growth, aggressive stock management, and even
speculation.
 Value Investing
 focuses on companies that are out of favor with the
market.
 Value investors buy stocks whose prices are low
compared to their fundamentals
 Low price/earnings ratios, low price-to-book value ratios
and high dividend yields
 Investors expect some particular action – new
management, corporate take over, regulatory change, etc
– to drive up the price.
 cyclical industries such as automobiles, chemicals, steel,
financial services or real estate companies
 Use buy-hold strategy.
 Sector Rotation Style
 Investors choose stocks in specific industry sectors that
will do best depending on the current and projected
stages of the business/economic cycle.
 Do not look at the fundamentals of individual
companies but look at the economy as a whole and
forecast for the future.
 Divide stocks into four broad sectors interest sensitive
stocks, consumer durables, capital good manufacturers,
defensive stocks
 Investors rotate from one type of stock to the next as the
economy moves from one stage of the business cycle to
the next.
 Strategies - aggressive stock management and even a bit
of short-term trading.
 Momentum Investing
 Rely heavily on technical analysis – focuses on using
relative stock price movement to determine when to buy
and sell rather than fundamental of underlying
companies.
 aggressive stock management or speculation and shortterm trading strategies.
Preferred Stock
 Represents ownership in a corporation
 Fixed dividends and a claim on a company's assets that
is above that of common shareholders
 Issued with a RM100 par (face) value
Types of Preferred Stock
 Cumulative preferred stock - continuous claim to
dividends. Any unpaid dividends accumulate until the
corporation resumes paying them.
 Non-cumulative (straight) preferred - opposite of
cumulative preferred: it doesn't confer a steady claim
on dividends in the event of a dividend suspension
 Participating preferred - shareholders receive extra
dividends over their nominal
 Convertible preferred - converted to a certain
number of shares of common stock
Features of Preferred Stock
 Limited voting right
 When the company wants to merge with another
 When the company wants to liquidate a large portion of
its assets
 When the company wants to issue new bonds or
preferred stock
 Call provision
 the issuing company can repurchase the stock from the
shareholders.
 As a way to eliminate dividends, thus increasing
earnings for common shareholders.
 Conversion
 To convert to a specified number of shares of the issuing
company’s common stock.
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Adjustable-rate (floating-rate) preferred
Preference (prior preferred) stock
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A cumulative provision
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Advantages Investing in
Preferred Stocks
 Preferred stocks offer high current income.
 Preferred stockholders generally receive higher rate of
return than bondholders
 Small investors are encouraged by the low unit cost of
preferred stocks.
 Preferred stocks are less risky than common stock
Disadvantages Investing in
Preferred Stocks
 Return on preferred stocks is limited or fixed amount
 Capital gains potential is small
 Yield give-up relative to bond
 Yields have not always kept up with inflation
Valuation of Preferred Stock
Price =
Annual Dividend Income (D)
Prevailing Market Yield (K)