Transcript Stocks and Investment - The Independent School

Stock Terminology (continued)
• Investors make money in stocks in
two ways:
– Dividends
• Companies may make payment to
shareholders as part of the profits.
Different types of companies have different
dividend policies, which may change over
time
– Capital Gains (CG)
• Investors purchase shares in companies
with the expectation that the price of the
shares will increase. This increase in share
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Stock Terminology (continued)
• General Classifications of Common
Stock
– Blue-chip stocks
• Stocks of the largest and best managed
firms. This is not a specific list, but
changes over time
– Growth stocks
• Companies which are growing faster than
average and which generally reinvest
dividends. They generally have higher PE
and PB ratios than the market as a whole
– Value stocks
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Stock Terminology (continued)
• Income stocks
– Companies which pay dividends
regularly
• Cyclical stocks
– Companies whose share prices move
up and down with the state of the
economy
• Defensive stocks
– Companies whose share prices move
opposite to the state of the economy
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D. Why Stocks Fluctuate in
Value?
• Why do stocks change in value?
– There are many different reasons why
stocks fluctuate in value. A few of the
more common reasons are due to
changes in:
• Interest rates
• Perceived risk of the company
• Expected company earnings, dividends,
and cash flow
• Supply and demand
• Investor sentiment and the market
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Why Stocks Fluctuate in Value
(continued)
• Interest rates
– Investors require a certain “expected
return” or discount rate to invest in
stocks. A major component of this
discount rate is interest rates
• As interest rates decrease, shareholder’s
discount rate also decreases (which is tied
to interest rates), and future earnings are
discounted by this lower rate, increasing
the value of the firm
• As interest rates increase, shareholders
require a higher discount rate, with all
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Why Stocks Fluctuate in Value
(continued)
• Perceived Risk of the Company
– There is an inverse relationship between
perceived risk of the firm and price
• As the perceived riskiness of a firm decreases,
investors are willing to pay more for the company
stock, resulting in an increase in stock price
• As the perceived riskiness of a firm increases,
investors are willing to pay less for the stock,
resulting in a decrease in stock price
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Why Stocks Fluctuate in Value
(continued)
• Expected Earnings, dividends, and
cash flow
– As earnings, dividends, and cash flow
per share increase beyond what was
expected, generally investors are willing
to pay more for the stock, and the stock
price increases
– As earnings, dividends, and cash flow
per share decreases beyond what was
expected by the market, investors are
less willing to pay for the stock, and
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Why Stocks Fluctuate in Value
(continued)
• Supply and demand
– Stock prices may rise or fall based on
supply and demand for their shares
• If a large shareholder needs to sell shares
of a stock to meet cash needs, supply
increases and the price is likely to decline
• Likewise, if a large investor gets new
money into their account, and decides to
increase their holding in the stock, the price
of that stock will likely rise as the investor
must pay a higher price to encourage
others to sell the stock
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Why Stocks Fluctuate in Value
(continued)
• Investor sentiment and the market
– Stock prices may rise or fall based on
general investor sentiment and how the
overall market is performing
• If investors are generally positive on stocks,
and the market is performing well, investors
will likely bid up the price of all stocks
• If investors sentiment is negative, and the
market is performing poorly, investors will
likely reduce their willingness to purchase
the stock, resulting in a lower stock price
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B. Major Types of Mutual
Funds
• What are the major types of Mutual
funds?
– The types of mutual funds generally
follow the major asset classes
• Money market , stock, and bond mutual
funds
– Others specialty funds
•
•
•
•
Index funds
Exchange Traded Funds (ETFs)
Balanced funds
Asset allocation funds
Types of Mutual Funds (continued)
• Money market mutual funds
– Money market mutual funds are funds which
invest the majority of their assets in short-term
liquid financial instruments such as
commercial paper and government treasury
bills
• Their goal is to obtain a higher return, after fees
and expenses, than traditional bank savings or
checking accounts
Types of Mutual Funds (continued)
• Stock mutual funds
– Stock mutual funds are funds which invest a
majority of their assets in common stocks of
listed companies
– These funds generally have a specific
objective, i.e. “large-cap,” “small-cap”, “value,”
“growth,”, etc. which relates to the types of
stocks the mutual fund invests in
• Their goal is either to outperform their relative
benchmarks or to have a consistently high total
return
Types of Mutual Funds (continued)
• Bond mutual funds
– Bond mutual funds are funds which invest a
majority of their assets in bonds of specific
types of companies or institutions
– These funds generally have a specific
objective, i.e. “corporate,” “government”,
“municipals,” “growth,”, etc. which relates to
the types of bonds the mutual fund invests in
– In addition, most have a specific maturity
objective as well, which relates to the average
maturity of the bonds in the mutual fund’s
portfolio
• Their goal is to generally outperform their relative
benchmarks
Types of Mutual Funds (continued)
• Index funds (822 as of 3/3/2010 –
Morningstar)
– Index funds are mutual funds designed
to match the returns of a specific index
or benchmark
– Index funds can track many different
benchmarks, including the S&P500
(Large-cap stocks), Russell 5000 (smallcap stocks), MSCI EAFE (international
stocks), Lehman Aggregate (corporate
bonds), DJ REIT (Real estate
investment trusts), etc.
Types of Mutual Funds (continued)
• Balanced funds
– Balanced funds are mutual funds which
purchases both stocks and bonds generally in
a specific percentage or relationship, i.e. 60%
stocks and 40% bonds.
– Their benefit is that they perform the asset
allocation, stock selection, and rebalancing
decision for the investor in the fund.
• Their goal is to exceed the return of their
percentage-weighted relative benchmarks
Types of Mutual Funds (continued)
• Asset allocation funds
– Asset allocation funds are mutual funds which
rotate among stocks, bonds, and cash
– Asset allocation funds invest the fund’s assets
in the asset classes expected to perform the
best over the coming period of time
• Their goal is to exceed the return of their
percentage-weighted relative benchmarks after
costs and fees
Types of Mutual Funds (continued)
• Life-cycle funds
– Life cycle funds are funds which change their
allocation between stocks and bonds
depending on the age of the investor
– As an investor ages, life cycle funds reduce
their allocation to stocks and increase their
allocation to bonds, more consistent with the
goals and objectives of an older investor
– These funds seek to perform the asset
allocation decision normally done by the
investor and to reduce transaction costs as
well
• Their goal is to exceed the return of their
percentage-weighted relative benchmarks after
costs and fees