LECTURE 3: BASICS OF INVESTING IIToday’s ScheduleAdministrative IssuesLecture ContentMarket CapitalizationSlide 6Market Capitalization: ExampleDifferent CapitalizationsMarket Capitalization PerspectiveComparing Small and Large Caps (S&P 500 vs. S&P 600) – last decadeComparing Small and Large Caps (S&P500 vs. S&P 600) – Past 2 YearsStock Splits Stock BuybacksStock SplitsSlide 14Slide 15Slide 16Stock BuybacksSlide 18Investing on Margin / Short SellingInvesting on MarginSlide 21Margin ExampleMargin Example continuedShorting StocksShorting ExampleSlide 26Sector / Industries Cyclical vs. Non-CyclicalSector vs. IndustrySector vs. IndustriesRecent Industry Performance (http://stockcharts.com/charts/performance/Industry1.html)Cyclical Stocks / IndustriesCyclical vs. Non-Cyclical StocksSummaryFor Next WeekCurrent EventsReading / HomeworkLECTURE 3:BASICS OF INVESTING IIEconomics 98/198 Decal Spring 2008Today’s ScheduleAdministrative IssuesLast Week’s LectureLecture ContentBasics of InvestingMarket capitalizationEarning reportsStocks splits / stock buybacksInvesting on MarginShort-sellingIndustries / SectorsCurrent EventsAssigned Reading / Next WeekAdministrative IssuesEnrollmentMake sure you’re signed up on Tele-BearsInvestopedia Simulation CompetitionSubmit your $5 into the class envelopeMake sure you write username on sign-up sheetStart trading! Investor’s Business Daily online subscriptionNew PresentationLecture ContentMarket CapitalizationMarket CapitalizationAlso 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: ExampleExample. Amazing DeCal Cookies Co., Ltd.Share Price $20Shares Outstanding: 50,000,000 sharesMarket cap?Example. Berkeley Traders Co., Ltd.Share Price $100Shares Outstanding: 1,000,000 sharesMarket Cap?Different CapitalizationsNot exact, but general guidelines for size categoriesLarge CapCompanies with $10b - $200b market capOften referred to as “blue-chip” stocks (low volatility, dividends)“Mega-Cap” - $200b+ (HUGE)Mid CapCompanies with $2b - $10b market capSmall CapCompanies with $300m - $2b market cap Typically newer, relatively younger companiesCan present potential for greater capital gains, but at greater risk“Micro-cap” - $50m-$300m market cap – VERY SMALLMarket Capitalization PerspectiveLarge CapMicrosoft (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 - CapLogitech International (Nasdaq: LOGI) $5 billionJ Crew Group Inc. (NYSE: JCG) $2.6 billionBarnes & Noble (NYSE: BKS) $1.9 billionPapa Johns (PZZA) $694 millionTradeStation Group (TRAD) $471 millionSource: Google Finance as of 2/12/2008 closing pricesComparing Small and Large Caps(S&P 500 vs. S&P 600) – last decadeBlack line = S&P 500 Orange line = S&P 600Comparing Small and Large Caps(S&P500 vs. S&P 600) – Past 2 YearsBlack line = S&P500 Orange line = S&P 600Stock SplitsStock BuybacksStock SplitsWhen a company divides the number of its existing stocks into multiple sharesIn 2-for-1 split, each stockholder gets an additional share for each share he or she holdsAlso, value of each share is reduced in half: 2 shares now equal original value of 1 share before split (total value not changed)Stock SplitsIf you still don’t get it, think of it this way..If you have a $100 bill, and I exchange with you two $50 billsHow many bills do you have?What is the total value of money you have?Stock SplitsWhy 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 stockSome also say stock split will increase price because it is a signal of strong growth Increases stock’s liquidity (What is liquidity?)Stock SplitsEffectsExcessive stock splits may hurt a stock’s pricePros and shrewd traders sometimes use excitement generated by oversized or excessive split as an opportunity to sell and take their profitsOversized splits create substantially larger supplyStock BuybacksWhen a company buys back its own shares in the market placeAlso 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 marketStock Buybacks# of shares outstanding go down as these shares are bought by the companyMajor 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 companyWe’ll discuss this more laterAre they good or bad?Not definitive answer, depends on the situationInvesting on Margin / Short SellingInvesting on MarginBorrowing money from brokerages to investGenerally, maximum 50% of a purchase can be on marginHowever, when borrow money, have to pay an interest rate on money borrowedEx. 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 MarginPROSPotential to get greater profits than investing with only cash because you profit from money you don’t haveCONSWorks against you when you lose money – can get really ugly with lossesCharged interest for money you borrowMargin ExampleJoe 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) +$5,000100 shares @ $50 (margin) +$5,000---------------------------------------------------Total Investment $10,000(200 shares @ $50)Margin Example continuedSMRT goes through the roof and increases 100% in 10 months to $100. Joe smartly sells and takes profits.SMRT Investment (200sh@$100) +$20,000Money borrowed from brokerage -$5,000Interest on borrowed money -$500Original Investment -$5,000-------------------------------------------------------------------Profit $9,500% Return
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