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1 Rates of return time to double o Mutual fund returns o Holding period return total return beginning price o HPR with reinvested dividends and capital gains number of shares at the end of the period ending price number of shares beginning of period initial price number of shares beginning period initial price o Measuring long term returns use internal rate of return p300 o Returns on closed end funds used to be calculated with NAV but now use market price to include discount premium Substitute market value of stock for NAV in the HPR formula NAV measures are thought to be a better measure of how the fund is run can t control supply demand o Rule of 72 72 interest rate will approximately give you the time it would take an investment to double o Mutual fund risk o More speculation leads to more change in NAV if downturn o Affected by market risk not business or financial risk o All subject to inflation interest rate and market risks but if the fund is conservative the risk is lower o EPS net profit after tax preferred dividends number of common stock shares outstanding 2 Dividend yield compared to other investments Increasing streams of dividend s shores up stock returns in soft markets Dividends are expected to increase 3 5 per year Annual dividend received per share current stock market price Reinvestment plans available o Dividends will automatically be reinvested in the shares of common stock if it s good enough to invest in it s good enough to reinvest in o Convenient and inexpensive way to get capital sometimes below market price o Many times you can buy more than what the dividend allows free of commission o Still treated as taxable income though the same as it would be if it wasn t reinvested 3 Common place aspects to stocks Stockholders are residual owners in the company Get capitals gains and or dividends o Returns from capital gains vary much more than returns from dividends o Generally positive returns over time o Investing does include risk 2000 2008 had negative capital gain Advantages o High grade corporate bonds earned annual returns half as big as return on common stock o They avoid inflation o Liquid easy to buy and sell with low transaction costs o Can buy any amount many are only 50 where bonds are expensive and mutual funds may have minimums Disadvantages o Risk business and financial risk market risk purchasing power and event risk o Prices are volatile so hard to value and buy top performers o Sacrifice in current income bonds pay coupons Publicly traded issues shares that are readily available to general public and bought and sold in the open market o In 2008 the value of stocks was 12 trillion Classified common stock o Different people will get different rights voting rights or dividend obligations o Ford class A owned by the public o Ford class B Owned by Ford family Class B gets 40 absolute control over the company 4 Rights offering Two ways to issue new shares o Rights offering new shares go to existing shareholders first If I own 1 I will be allowed to buy 1 of the new shares being issued You can also sell your rights o Public offering IPO available to all public 5 Round lot retail 100 shares of stock or multiples of 100 Odd lot less than 100 shares bought o Odd lot dealer charges high fees Odd lot differential normal commission charge 10 25 cents per share 6 Par book market values Par value stated face value of the stock o Only really used for accounting purposes Book Value Represents the amount of stockholders equity in the firm o Assets liabilities preferred stock o Book value per share divide book value by common stock outstanding o Market price normally above book value per share Market Value prevailing market price of an issue o Market capitalization market value of stock number of shares outstanding Investment value What investors think the stock should be trading for o Most important in analyzing stock 7 Calculate dividend yield Annual dividend received per share current stock market price 8 Processes of securities analysis Security analysis consists of gathering information organizing it into a logical framework and then using it to determine common stock s intrinsic value o Intrinsic Value Estimates of stock s future cash flows Discount rate used to convert to present value Risk associated with the future performance helps to determine discount rate Satisfactory candidate offers a level of return proportionate to the level of risk 9 Fundamental technical analysis Fundamental analysis o The top down approach Economic analysis then industry analysis then fundamental analysis of a specific company in that industry Fundamentals investment decisions liquidity use of debt profit margin and earnings growth Fundamental analysis reasonable if not all market values reflect their stock s intrinsic values and if investors can find those undervalued stocks If the intrinsic value is greater than the market value then buy the stock If not then sell the stock or don t buy it If the intrinsic value is greater than the market value it is believed that the stock is underpriced in the market Company analysis helps to estimate a stock s future cash flows o Basically try to figure out what you believe a company to be worth and if it s worth more than the stock is selling at you can receive a gain Gordon growth model is used Technical analysis o Efficient market hypothesis Securities are rarely if ever substantially mispriced because the market is efficient in processing new information Therefore no security analysis is capable of identifying mispriced securities more often than random chance can If this is so is security analysis a waste of time Financial analysts make the market as efficient as it is Stocks trade at the proper intrinsic value because there are analysts who convey what that value actually is The stock market isn t perfectly efficient There are errors and therefore some stocks in the market for a short period of time will not be trading at their intrinsic values It s hard to be the first investor to find that stock o Because some investors believe the market to be efficient analysts look at a company s past performance People tend to have the same behavior over time so analysts look for trends in a company s stock trading history If a company s stock price fell by the same amount for the past few recessions investors can expect the stock price to fall by around that same amount if another recession hits 10 Stock ownership definition avg return


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FSU FIN 3244 - Rates of return

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