Lecture 3: - Open Computing Facility
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Transcript Lecture 3: - Open Computing Facility
LECTURE 3:
BASICS OF INVESTING II
Economics 98/198 Decal
Spring 2008
Today’s Schedule
Administrative Issues
Current Events
Last Week’s Lecture
Lecture Content
Basics of Investing
Market capitalization
Earning reports
Stocks splits / stock buybacks
Investing on Margin
Short-selling
Industries / Sectors
Assigned Reading / Next Week
Administrative Issues
Enrollment
Make sure you’re registered on Tele-Bears
Investopedia Simulation Competition
Submit your $5 into the class envelope
Make sure you write username on sign-up sheet
Start trading!
Investor’s Business Daily online subscription
Next week’s class: 20 Barrows
Lecture Content
Last Week
Stock Basics
What is stock? What are its main characteristics?
Dividends
Market Exchanges
How are stocks traded?
Primary vs. Secondary Markets
Indices (Index)
What is an index? What are the main ones?
Brokerage
Full service vs. discount
Commissions
Different types of orders
Market / Limit / Stops / Stop-limit
Different Types of Orders, revisited
Different types of Orders
Limit Order
An order to buy or sell a set number of shares at specified price of
better. Limit orders usually cost more, but useful for getting
specified price.
Stop Order
An order placed for a security for when the price surpasses a
particular point, which helps buy or sell at a particular price.
Limiting loss or locking profits. Many people use this during
vacations.
Stop Limit Order
Executed at a specified price (or better) after a given stop price has
been reached. Order becomes then a limit order to buy (or sell) at
the limit price or better
Precision purposes
Market Capitalization
Market Capitalization
Also 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, management, & insiders)
Market Capitalization
Example. Amazing DeCal Cookies Co., Ltd.
Share Price $20
Shares Outstanding: 50,000,000 shares
Market cap?
Example. Berkeley Traders Co., Ltd.
Share Price $100
Shares Outstanding: 1,000,000 shares
Market Cap?
Different Capitalizations
Not exact, but general guidelines for size categories
Large Cap
Companies with $10b - $200b market cap
Often referred to as “blue-chip” stocks (low volatility, dividends)
“Mega-Cap” - $200b+ (HUGE)
Mid Cap
Companies with $2b - $10b market cap
Small Cap
Companies with $300m - $2b market cap
Typically newer, relatively younger companies
Can present potential for greater capital gains, but at greater risk
“Micro-cap” - $50m-$300m market cap – VERY SMALL
Market Capitalization Perspective
Large Cap
Microsoft (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) $40 billion
Small/Mid - Cap
Logitech International (Nasdaq: LOGI) $5 billion
Chipotle (NYSE: CMG) $3.6 billion
Crocs Inc. (Nadaq: CROX) $2.76 billion
J Crew Group Inc. (NYSE: JCG) $2.62 billion
Barnes & Noble (NYSE: BKS) $1.88 billion
Papa Johns (Nasdaq: PZZA) $694 million
Source: Google Finance
Comparing Small and Large Caps
(S&P 500 vs. S&P 600) – last decade
Black line = S&P 500
Source: Stockcharts.com
Orange line = S&P 600
Comparing Small and Large Caps
(Dow Jones vs. S&P 600) - recent
Blue line = Dow Jones
Source: Stockcharts.com
Red line = S&P 600
Comparing Large/Mid/Small Cap
Source: Stockcharts.com
Stock Splits
Stock Buybacks
Stock Splits
When a company divides the number of its
existing stocks into multiple shares
In 2-for-1 split, each stockholder gets an
additional share for each share held
Also, value of each share is reduced in half:
2 shares now equal original value of 1 share
before split (total value not changed)
Stock Splits
Alternatively, think of it this way…
If you have a $100 bill, and I exchange with you two
$50 bills
How many bills do you have?
What is the total value of money you have?
Stock Splits
Why 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 stock
Some also say stock split will increase price because it is a
signal of strong growth
Increases stock’s liquidity (this increases when ↑ in #
of outstanding shares)
Stock Splits
Effects
Excessive stock splits may hurt a stock’s price
Pros and shrewd traders sometimes use excitement
generated by oversized or excessive split as an opportunity
to sell and take their profits
Oversized splits create substantially larger supply
Stock Buybacks
When a company buys back its own shares in the
market place
Also known as “share repurchase”
Why do it?
Management believes its stock is undervalued (its too
cheap)
Management has confidence in the company and
want to send a message the market
Stock Buybacks
# of shares outstanding go down as these shares are
bought by the company
Major 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 company
We’ll discuss this more later
Are they good or bad?
Not definitive answer, depends on the situation
Investing on Margin / Short Selling
Investing on Margin
Borrowing money from brokerages to invest
Generally, maximum 50% of a purchase can be on
margin
However, when borrowing money, have to pay
interest on money borrowed
Ex. 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 Margin
PROS
Potential to get greater profits than investing
with only cash because you profit from money
you don’t have
CONS
Works against you when you lose money – can
get really ugly with losses
Charged interest
Marginal calls
Margin Example
Joe 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)
+$5,000
100 shares @ $50 (margin)
+$5,000
--------------------------------------------------Total Investment
$10,000
(200 shares @ $50)
Margin Example continued
SMRT goes through the roof and increases 100% in 10
months to $100. Joe smartly sells and takes profits.
SMRT Investment (200sh@$100)
Money borrowed from brokerage
Interest on borrowed money
Original Investment
+$20,000
-$5,000
-$500
-$5,000
-------------------------------------------------------------------
Profit
% Return ($9,500/$5,000)
vs. % Return (cash investment only)
$9,500
190%
100%
Shorting Stocks
Betting a stock will go down and attempting to
profit from that downward movement
1.
You essentially “borrow” shares from another
investor (account must be able to trade on margin)
2. You sell those shares at the market price
3. You then wait and root for the stock price to tumble
4. Then you cash out, whether at a profit of loss
5. You then buy the shares at the new market price
and return the shares to their owner
Shorting Example
Scenario 1
Mr. Giant shorts 1000 shares of Lampere Co. at $20 a
share – his account gets credited with $20,000
Lampere Co. stock plummets to $10 a share
Borrowed and sold short 1000 shares at $20
+$20,000
Bought back and returned 1000 shares at $10
-$10,000
----------------------------------------------------------------------------Profit
+$10,000
% Gain
100%
Shorting Example
Scenario 2
Mr. Giant shorts 1000 shares of Lampere Co. at $20 a
share – his account gets credited with $20,000
Lampere Co. stock skyrockets to $60 a share
Borrowed and sold short 1000 shares at $20
+$20,000
Bought back and returned 1000 shares at $60
-$60,000
----------------------------------------------------------------------------Profit
-$40,000
% Loss
-200%
Going Short
PROS
Can profit during market downturns
CONS
More difficult than buying stocks
Betting against history
Must constantly monitor positions
Sector / Industries
Cyclical vs. Non-Cyclical
Sector vs. Industry
Often used interchangeably, but actually mean slightly
different things
Sectors are the general segments in the economy within
which large groups of companies can be categorized into
About a dozen sectors in the economy
Example. Financial Sector, Technology, Basic Materials
Industry describes a much more specific grouping of
companies with highly similar business activities
Break down sectors into much more defined groups
Can be small, but also very large in numbers
Example. Financial Sector Asset Management, Insurance,
Commercial Banks, Investment Banks, etc.
Sector vs. Industries
Top sectors / industries rotate every cycle
Important to know which sectors / industries are leading
the market and performing well
Why? Let’s think back to 1998
Technology, software, telecom: leading industries then
If you invested in those industries , the price would have
likely made a solid, if not major, price increase
Stock prices of companies in the same / similar
industry usually (not always) move in a similar fashion
Recent Industry Performance
Recent Sector Performance
Cyclical Stocks / Industries
The term refers to how correlated a company’s
price (or industry) is relative to economic
fluctuations
Non-cyclical stocks (also called defensive stocks)
refer to companies not as susceptible to economic
fluctuations
Example. Household non-durables, tobacco, utilities,
defense
These are often goods that necessities rather than
luxuries
Cyclical vs. Non-Cyclical Stocks
Ford = Blue
Red – Florida Public Utilities
Summary
Market Capitalization
Small caps vs. large caps
Stock Splits
Stock Buybacks
Shorting Stocks
Margin
Industries vs. Sectors
Cyclical Stocks / Industries
For Next Week
Quiz on Stock Market Basics
Introduction to Other Investment Securities
Bonds / Mutual Funds / Exchange-Traded Funds
Market Psychology
Emotions involved with stock investing
Basic Investing Concept
Compounding
Investing versus Speculating
Investment Style – Risk/Reward, Active/Passive
Managing your Portfolio
Reading / Homework
Beginner’s Guide to Financial Statements (SEC)
http://www.sec.gov/investor/pubs/begfinstmtguide.h
tm
Are Buyback Stocks Still Good for Investors?
Margin Trading
Online News Sources
Reuters Business
www.reuters.com
Yahoo! Finance
Finance.yahoo.com
Investor Guide
www.investorguide.com
Investor’s Business Daily
www.investors.com
Great Site: Moneychimp
http://www.moneychimp.com/
Brokerage Review
Charles Schwab
Scottrade
Zecco
Current Events
Current Events
Yahoo rejects Microsoft’s $45B bid
News Corp – Integrating MySpace and Yahoo
Not just Subprime
The Dow makes changes
Roger Clemens testifies before Congress
Next Week
Remember: Next week’s class is in 20 Barrows