Investment Philosophy and Strategy

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INVESTMENT PHILOSOPHY AND STRATEGY

Economics Finance Unit Four DD Marshall High School Mr. Cline * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Common stock: Common stock is an ownership share of a company. The company initially sells common stock through an initial public offering, or IPO. The stock is then traded among investors in secondary markets. Owners of common stock take more risk than owners of other types of stock, but they also receive a greater reward if the company performs well.

• Preferred stock: Preferred stock is also an ownership share of a company. However, this type of stock differs from common stock in that the dividend is guaranteed, and the dividend is paid before dividends on common stock are paid. However, if the company’s profits increase, the dividend is not increased accordingly, so return is limited.

• Classes of stock: Some companies have multiple classes of stock; these multiple classes allow for ownership in a specific subsidiary of a company. Each class is designated for specific investment purposes. Companies may also have different dividend policies for different classes of stock.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

Businesses 401-k Y $15,500 w/plans Businesses Roth 401-k Y 15,500 w/plans Non-profit, tax- 403-b Y 15,500 exempt Non-profit, tax- Roth 403-b Y 15,500 exempt State/municipaliti 457 Y 15,500 es SEP IRA Y 46,000 Small businesses

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Shareholders (stockholders): Shareholders, or stockholders, are investors who own shares, or equity, in a company. When you purchase shares of stock from a company, either individually or through a mutual fund, you become a partial owner in that company.

• Voting rights: Shareholders have the right to vote on major policy issues. Usually, a shareholder is given one vote for each share of common stock that he or she owns. However, some companies issue different classes of shares, and some classes have extra voting rights. Generally, shareholders vote by proxy, a practice similar to voting with an absentee ballot.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Book value per share: The book value is the value of each share of the company’s stock after the company’s liabilities have been subtracted from the company’s assets.

• To find the book value per share, subtract the company’s liabilities from the company’s assets to find the company owner’s equity (as seen on a balance sheet); then divide this amount by the weighted average number of shares that are outstanding.

• The book value per share is based on the value the company’s assets at their purchase cost, less depreciation, or the amount the asset has decreased in value since it was purchased.

• In other words, it is the value of the company’s assets at cost less their depreciated amount. A more meaningful ratio is the price-to-book ratio, which is found by dividing the market price per share by the book value per share. This ratio gives an indication of how much money you are paying for every dollar of assets.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Earnings per share: Earnings per share refers to the level of earnings of each share of stock—not necessarily the amount that will be paid out as dividends.

• Earnings per share are calculated by dividing the amount of company earnings (after payment of preferred stock dividends) after taxes by the weighted average number of shares that are outstanding.

• Earnings per share equals the net income minus preferred stock dividends divided by the weighted average number of common shares outstanding.

• The price earnings ratio, the current stock price divided by the earnings per share, may be more helpful. This ratio gives an indication of how much money you are paying for every dollar of earnings.

• Dividend yield: The dividend yield refers to the annual yield of dividends per share divided by the current market price. The dividend yield indicates the amount of return on the current share price.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Stock splits: If the price of a stock is too high, most investors are reluctant to buy new shares.

• To keep the price of a company’s stock in the preferred buying range (roughly $6 to $100 per share) a company will often split a stock.

• A stock split of (x) for one stock would cause the current share price to decline by the stock price divided by (x).

• Through splitting a stock, a company is able to keep its share price within buying range.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• For example, assume you have ten shares of stock priced at $100 per share ($1,000 total). If the stock splits two-for-one, you would then have twenty shares (ten shares multiplied by two).

• The price of the stock would most likely decline from $100 per share to $50 per share ($100 divided by two).

• You would still have the same total value of $1,000, but the price for each share would now be $50 per share instead of $100 per share, and you would now have twenty shares instead of ten shares.

• While a stock split has no impact on a company’s value, it may be a positive indicator of the company’s prospects.

• Reverse split: If the price of the company’s stock is too low, the company may do a reverse split: a reverse split reduces the number of shares outstanding and raises the stock’s price to bring the price closer to the preferred buying range. A reverse split is the opposite of a stock split.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * Stock Terminology

• There are a number of important terms that you should understand before you begin working with stocks.

• Stock repurchases: Stock repurchases happen when companies buy back their own shares. This is generally positive for the investor because each time a company repurchases stock, the investor owns a larger proportion of the company.

Retirement Plan Investment Maximum Tax-deferred Tax-eliminated For Employees Vehicle: Amount of:

SIMPLE IRA Y 10,500 Small businesses IRA Y 5,000 Individuals Roth IRA Y 5,000 Individuals Individual Education IRA Y 2,000 Education Individual 529 Plan Y >300,000 p.c. Education * The Value of Stocks

• The goal of stock valuation is to determine the intrinsic value of a company (in other words, the company’s fundamental economic value).

• If the market price of the company’s stock is greater than the company’s intrinsic value, the investor should sell the stock. If the market price of the company’s stock is less than the company’s intrinsic value, the investor should buy the stock.

• Determining a company’s intrinsic value is one of the most challenging responsibilities that an investor has. Determining this value is accomplished using various tools, including dividend discount models, fundamental analysis, cash-flow analysis, and technical analysis.

• Dividend discount models: Dividend discount models regard the value of a stock as the present value of all future dividends that will be earned while holding that stock; these dividends are discounted at the company’s required rate of return or discount rate.

• The value of a company’s common stock is found by dividing the dividend you expect to have in the future by the current required rate of return you require for holding this stock, or discount rate (k), minus the stock’s long-term growth rate (g).

* The Value of Stocks • Value of common stock = D1/ ( k – g )

• The letter g represents how fast you expect the stock to grow over the next fifty years—the long-term growth. It is very difficult to determine the exact value of a company’s stock because you cannot project either the dollar amount of future dividends or the growth rate. However, this model may still be helpful in your stock analysis.

• Cash-flow analysis: Cash-flow analysis assumes that the value of the company is measured by the discounted value of the free cash flows to all shareholders, including equity shareholders.

• Free cash flows are defined as cash flows in addition to cash flows required for operations and investment.

• To value a stock based on cash-flow analysis, investors build cash-flow models that forecast expected cash flows to all shareholders and to the company as a whole.

• While cash-flow analysis is helpful in determining intrinsic value, the value of the company often lies in areas that are difficult to quantify in terms of cash flow, such as video libraries, for entertainment companies, or patents, for medical companies. • Technical analysis: Technical analysis assumes that supply and demand are the key factors that are necessary to understand stock prices and markets.

• Technical analysis focuses on the psychological factors that determine a company’s value, such as greed and fear, as well as the economic factors that determine a company’s value.

• While major research studies have found that this type of analysis is not as reliable in predicting stock prices, many of the tools used in technical analysis are helpful in managing portfolios, such as price charting, moving average graphs, and other types of price analysis.

• Fundamental analysis: Fundamental analysis assumes that the value of the stock can be determined by the future earnings of the company.

• Analysts spend a great deal of time investigating the company, the industry, the global industry, and the global economy to determine the intrinsic value of the company and gather the necessary information for fundamental analysis.

• Fundamental analysis has been found to be a valuable tool for stock valuation, particularly when analysts are able to forecast earnings that are significantly different than the market consensus.