FINAL EXAM STUDY GUIDE CH 11 13 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 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 2 Dividend Yield Compared to Other Instruments Cash dividends they tend to increase over time as companies earnings grow The average annual increase in dividends is around 3 to 5 This trend represents good news for investors because a steadily increasing stream of dividends tends to shore up stock returns in soft markets A convenient way of assessing the amount of dividends Dividend yield received is to measure the stock s dividend yield the investment dollar indicates the rate of current income earned on Dividend yield annual dividends received per share Current market price of the stock To put dividend yield into perspective it is helpful to look at a company s dividend payout ratio Dividend payout ratio describes that portion of earnings per share EPS that s paid out as dividends 1 Dividend payout ratio dividend per share Earnings per share The appeal of cash dividends took a giant leap forward in 03 when the federal tax code changed to reduce the tax on dividends Now both dividends and capital gains are taxed at the same low preferential rate of 15 or less There more people want to buy dividend paying stocks 3 Commonplace Aspects to Stocks Stockholders are residual owners in the company Get capitals gains and or dividends Returns from capital gains vary much more than returns from dividends Generally positive returns over time 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 Disadvantages Risk business and financial risk market risk purchasing power and event risk Prices are volatile so hard to value and buy top performers o Publicly traded issues shares that are readily available to general public and bought and sold in the open market o Classified common stock Different people will get different rights voting rights or dividend obligations 4 Rights Offering Two ways to issue new shares 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 Public offering IPO available to all public A stock right gives the shareholder the right to purchase new shares of the company s stock in proportion to his or her current ownership position 5 Round Lots Retail 100 shares of stock or multiples of 100 Odd lot less than 100 shares bought Odd lot dealer charges high fees Odd lot differential normal commission charge 10 25 cents per share Group of 100 shares of a stock or any group of shares that can be evenly divided by 100 such as 500 2 600 or 14 300 o A round lot has historically been the smallest order that can be placed through an exchange However round lot one now allows for the execution of orders as small as one share on some exchanges A round lot may also be referred to as a normal trading unit 6 Par Book Market Values Par value the stated or face value of a stock Book value the amount of stockholders equity in a firm equals the amount of the firm s assets minus the firm s liabilities and preferred stock the prevailing market price of a security Market value Indicates how the market participants as a whole have assessed the worth of a share of stock By multiplying the market price by the number of shares outstanding we can also find the market value of the firm aka market capitalization 7 Calculate Dividend Yield o Cash dividends they tend to increase over time as companies earnings grow o The average annual increase in dividends is around 3 to 5 measures dividends on a relative percentage basis Dividend yield rather than on an absolute dollar basis investment dollar Dividend yield indicates the rate of current income earned on the Dividend yield annual dividends received per share Current market price of the stock To put dividend yield into perspective it is helpful to look at a company s dividend payout ratio Dividend payout ratio describes that portion of earnings per share EPS that s paid out as dividend 8 Process of Securities Analysis 0 Security analysis consists of gathering information organizing it into a logical framework and then using it to determine common stock s intrinsic value a Given a rate of return that s compatible with the amount of risk involved in a proposed transaction intrinsic value provides a measure of the underlying worth of a share of stock helps provide info if a stock is undervalued fairly priced or overvalued iii Intrinsic Value 1 Estimates of stock s future cash flows 2 Discount rate used to convert to present value 3 Risk associated with the future performance helps to determine discount rate Satisfactory candidate offers a level of return proportionate to the level of risk 3 Traditional security analysis usually takes a top down approach 0 Begins with economic analysis moves to industry analysis and then to fundamental analysis of a specific company a Economic analysis assess the general state of the economy and its potential effects on businesses consists of general study of the prevailing economic environment often on both a global and domestic basis such analysis is meant to help investors gain insight into the underlying condition of the economy and the potential impact it might have on the behavior of share prices It can go b Fundamental analysis looks at the financial conditions and operating results of the company it includes the company s investment decisions the liquidity of its assets its use of debt its profits margins and earnings growth c Once an analyst has synthesized all of the info from the economic industry and fundamental analysis the analyst uses the info to
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