applying the planning process Chapter 12 Investing in Stocks Where Does This Fit in Your Comprehensive Financial Plan Protection Plan for death and incapacity Chapters 16 17 Build wealth Save and invest to meet short term and long term goals Chapters 11 15 Secure basic needs Liquidity consumer purchases and credit decisions insurance employee benefits Chapters 5 10 What is common stock A corporation is a type of business organization that is a legal entity separate from its owners Common stock is a share of ownership in a corporation If you own 1 share and there are 1 million shares outstanding you own 1 1 000 000th of the company Establish a firm foundation Evaluate your finances acquire tools and skills set goals develop a budget Chapters 1 4 Why do corporations issue stock Original owners of a company eventually need more funds to help the company grow Example Google Co founders Larry Page and Sergei Brin decided to issue stock in 2004 to raise almost 3 billion The new funds would enable them to expand the company invest in additional equipment increae their number of customers and advertisers Primary versus Secondary Market Primary market Where stocks are sold to the public for the first time Called an initial public offering or IPO Secondary market Where stocks are bought and sold between investors Securities exchanges or over the counter 1 Stockholder rights Stockholders have a residual claim Proportionate share of what is left over after higher priority claims have been met Stockholders have the right to vote 1 share 1 vote Vote for Board of Directors and major changes such as mergers Stockholders have limited liability Stockholder rights Some stockholders have preemptive rights The right to maintain your proportionate interest in a company when it issues additional shares Stockholders sometimes benefit from stock splits The company trades current shares of stock for a larger number of lower valued shares Example You own 100 shares at 80 each After stock 2 for 1 split you own 200 shares at 40 Cannot lose more than your original investment No management responsibility Higher long run returns than lower risk investments Liquidity Low interest rate sensitivity Diversifiable risk Main Disadvantage of Stocks Risk EXPECTED RETURN Advantages of Stock Investing D e riva tives S m a ll C om p a n y S to c k s Ju n k B o n d s L arg e C o m p a n y S to c k s R e al E s ta te P re fe rre d S to ck A A A C o rp o rate Bonds T re a su ry B o n ds T re as u ry B ills R IS K Classification of Stocks Income versus Growth Income stock pays higher than average dividends from a steady source of income Example utility stock Growth stocks are usually younger companies which are reinvesting their profits to support growth and therefore do not usually pay dividends Classification of Stocks Cyclical versus defensive Cyclical stock follows the business cycle advances and declines in the economy Example automobiles heavy manufacturing paper and steel Defensive stock remains stable during economic declines and have a history of stable earnings Example Kellogg s Procter and Gamble and utility stocks 2 Classification of Stocks Blue chip stock Safe investment in strongest and most respected companies Example Kellogg s or General Electric Generally attracts conservative investors Types of Orders Market order Request to buy or sell at whatever the market price is at the time your trade is finalized Limit order Request to buy at the market price as long as it is less than a maximum price limit you indicate Request to sell at the market price as long it is not less than a minimum price limit you indicate Stock Valuation Methods Fundamental analysis Analyze many factors that are expected to influence stock prices Company performance industry factors economic conditions Discounted dividend model Value of a share is the present value of expected future dividends 3