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The Role of Stockbrokers

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The Role of Stockbrokers • Stockbrokers • Act as intermediaries between buyers and sellers of securities • Typically paid by commissions • Must be licensed by SEC and securities exchanges where they place orders • Client places order, stockbroker sends order to brokerage firms, who executes order on the exchanges where firm owns seats Types of Brokerage Firms • Full-Service Broker • Offers broad range of services and products • Provides research and investment advice • Examples: Merrill Lynch, A.G. Edwards • Premium Discount Broker • Low commissions • Limited research or investment advice • Examples: Charles Schwab Types of Brokerage Firms (cont’d) • Basic Discount Brokers • Main focus is executing trades electronically online • No research or investment advice • Commissions are at deep-discount Selecting a Stockbroker • Find someone who understands your investment goals • Consider the investing style and goals of your stockbroker • Be prepared to pay higher fees for advice and help from full-service brokers • Ask for referrals from friends or business associates • Beware of churning: increasing commissions by causing excessive trading of clients’ accounts Table 3.5 Major Full-Service, Premium Discount, and Basic Discount Brokers Types of Brokerage Accounts • Custodial Account: brokerage account for a minor that requires parent or guardian to handle transactions • Cash Account: brokerage account that can only make cash transactions • Margin Account: brokerage account in which the brokerage firms extends borrowing privileges • Wrap Account: account that shifts investment decisions to a professional money manager and charges a flat annual fee Basic Types of Orders • Odd-lot Orders • Orders for less than 100 shares of stock • Round-lot Orders • Orders for a 100-share unit or multiples thereof • Market Orders • Orders to buy or sell stock at best price available when order is placed • Fastest way to fill order Basic Types of Orders (cont’d) • Limit Orders • Order to buy at or below a specified price or to sell at or above a specified price • If price limits are not met, order is not filled • Fill-or-Kill Orders • Limit orders which is canceled if not filled immediately • Day Orders • Limit orders that expires at end of the day if not filled • Good-’til-Canceled (GTC) Orders • Limit orders that remains in effect for six months unless filled, canceled, or renewed Basic Types of Orders (cont’d) • Stop-Loss (Stop) Orders • Typically used to protect investors from stock price declines • “Suspended” order is placed to sell a stock if price reaches or falls below a specified level • Orders can be day orders or GTC orders • Once activated, becomes a market order • Can also use stop orders to buy stocks, such as to limit risk on short sales • Stop-Limit Orders • Orders to sell stock at or better than specified price • Prevents sales at undesirable price • No sale may occur if prices continues to decline Tips for Successful Online Trades • Know how to place and confirm orders • Verify stock ticker symbols • Use limit orders • Check and recheck orders—you pay for typos • Don’t get carried away • Follow a strategy • Don’t churn • Avoid or limit margin orders • Open accounts with two brokers • Double-check orders for accuracy after completion Trading Considerations • Transaction Costs • Fixed commissions used on small trades • Negotiated commissions may be used on large trades • Securities Investor Protection Corporation (SIPC) • Protects against broker financial failure • Limits up to $500,000 for securities and $250,000 for cash • Does not guarantee against churning or bad broker advice Using an Investment Advisor • Advisors are required to be registered with SEC • No law or regulatory body guarantees competence • Look for advisors with experience • Look for advisors with professional designations • Chartered Financial Analyst (CFA) • Certified Investment Management Analyst (CIMA) • Chartered Investment Counselor (CIC) • Certified Financial Planner (CFP) • Chartered Financial Consultant (ChFC) • Chartered Life Underwriter (CLU) • Certified Public Accountant (CPA) Paying an Investment Advisor • Typical professional investment advice fees • Small portfolios: annual fees between 2% and 3% of funds under management • Large portfolios: annual fees between 0.25% and 0.75% of funds under management • Check the track record and reputation of advisor • Expect lots of questions from good advisor to assess your investing expertise Investment Clubs • Investments Clubs • A legal partnership formed by investors to pool their knowledge and money • Members make stock recommendations and analyze stock performance • Better Investing Community assists in organizing clubs and provides educational tools • Better Investing Community has over 200,000 investors in over 16,000 investment clubs Financial Ratios • Analyzing financial statement information is one of the most important elements in the fundamental analysis process • Financial ratios help with this process • Study relationships between financial statement accounts • Financial ratios allow investors to work with numbers in an organized fashion. • http://www.investopedia.com/university/ratios/ Groups of Financial Ratios • Liquidity Ratios: • Ability to meet day to day operating expenses • Activity Ratios: • How well company is managing assets • Leverage Ratios: • Measures the makeup of a company’s capital structure (debt relative to equity) • Profitability Ratios: • Measures how successful the company is at creating profits • Common Stock Ratios: • Converts key financial information into per-share basis to simplify financial analysis Liquidity Ratios • Net Working Capital: • Net Working Capital = current assets – current liabilities • How many dollars of working capital are available to pay bills and grow the business • Higher or Lower Better? Activity Ratios • Inventory Turnover = Annual Sales/Inventory • How quickly the company is selling inventory • High or low better? • A low turnover is usually a bad sign because products tend to deteriorate as they sit in a warehouse. • A low turnover implies poor sales and, therefore, excess inventory. • A high ratio implies either strong sales or ineffective buying. • Companies selling perishable items have very high turnover. Leverage Ratios • Debt-Equity Ratio = Long-term debt / Stockholders’ Equity • How much debt the company is using to support its business compared to how much stockholders’ equity it is using to support business. • Higher or lower better? • Tricky…Generally Accepted that • High = More Risk • Low = Less Risk Leverage Ratios • Time Interest Earned = EBIT / Interest Expense • Measures ability of a firm to meet its fixed interest payments • High or Low indicates…. • High: Less Risk • Low: More Risk Profitability Ratios • Return on Assets (ROA) = Net profit after taxes / Total Assets • Amount of Profit earned on each dollar invested in assets; measures management’s efficiency at using assets. • Higher vs. Lower? Profitability Ratios • Return on Equity (ROE) = Net profit after taxes / Stockholders’ Equity • Amount of profit earned on each dollar invested by stockholders; measures management’s efficiency at using stockholders’ funds • Higher vs lower • Higher is better • Heavily impacted by leverage Common Stock Ratios • Basic Earnings Per Share (EPS): (Net profit after taxes – preferred dividends) / Number of common shares outstanding • Basic • Diluted • Stock options, convertible securities, warrants • Price to Earnings (P/E) Ratio: Market Price / EPS • Shows how the stock market is pricing the company’s common stock. • *Industry Specific* • Most widely used • Higher Ratio vs. Lower Ratio? Common Stock Ratios • What is the EPS & P/E ratio for Company X with: • Profits: $139.7 million • Market Capitalization: $2,565,322,500 • Market Price: $41.50 Common Stock Ratios • EPS = ($139,700,000 / 61,815,000) = • $2.26 per share • P/E Ratio: $41.50/$2.26 = • 18.4 • Depends on Industry Averages • Apparel: 18.57 • Pharmaceutical: 32.11 Common Stock Ratios • PE Growth Ratio (PEG) = PE Ratio / (3/5 yr growth rate in earnings) • If > 1: Stock may be fully valued • If = 1: Stock price in line w/ earnings growth • If < 1: Stock may be undervalued Common Stock Ratios • Enterprise Value (EV): measure of a company’s total value −EV = market value of stock + market value of preferred equity + market value of debt + minority interest – cash and investments −The theoretical takeover price if the company were to be bought. Common Stock Ratios • Enterprise Multiple (EV/EBITDA) = Enterprise Value / Earnings Before Interest, Taxes, Depreciation, & Amortization −Unlike the P/E ratio, it factors in debt −Useful for takeover candidates −High: Biotechnology −Low: Railways −Stocks with an Enterprise Multiple of less than 7x are generally considered a good value. Common Stock Ratios • Dividends per share = Annual Dividends / # of Shares • Amount of dividends paid out to common stockholders • Payout Ratio = Dividends per share / EPS • How much of its earnings a company pays out of stockholders in the form of dividends • Traditional payout ratios have been 40% to 60% • Recent trends have been towards lower payouts • High payouts are hard to maintain • Stock market does not like cuts in dividends Common Stock Ratios • Book Value per common share = Total Shareholder Equity – Preferred Equity/ # of Shares • Amount of money that a holder of a common share would get if a company were to liquidate. • Liquidation: • When a company chooses or is forced by a legal judgment or contract to turn assets into a "liquid" form (cash). Common Stock Ratios • Price to Book Ratio (P/B) = Stock Price / Total Assets – Total Liabilities −Compares the cost of a stock to the value of the company if it was broken up and sold today −A lower P/B ratio could mean that the stock is undervalued. −It could also mean that something is fundamentally wrong with the company. −Best to use for asset-heavy companies −Examples: Airlines, Banks Table 3.4 Popular Investment Websites.
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