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Unformatted text preview: Chapter 14: Common Stocks: Analysis And Strategy CHAPTER OVERVIEW Chapter 14 completes this two-chapter sequence on the analysis, valuation, and management of common stocks--the same sequence used earlier for bonds. This chapter concentrates on issues important to the analysis and management of common stocks, given that the valuation of stocks was discussed in Chapter 13. This arrangement allows us to efficiently cover common stocks by discussing valuation in Chapter 13 and analysis and management in Chapter 14. This provides an in-depth discussion of common stocks that in many cases will suffice for an introductory course; that is, instructors may choose to forego Part V on security analysis, or cover it in less detail. Students will be exposed to the basic terminology, ideas, and concepts involving common stocks by covering these three chapters. Chapter 14 begins by analyzing common stocks in terms of the impact of the market on common stocks (obviously a major consideration) and in terms of the required rate of return for common stocks (a very important concept covered briefly in earlier chapters). Now that we are analyzing stocks in detail, a full discussion of these two key topics is extremely valuable. Earlier chapters defined and briefly discussed systematic risk and beta, and we can now emphasize that all investors who plan to analyze and manage a portfolio of stocks must be keenly aware of market risk, both domestic and foreign. In a similar manner, in Chapter 13, in order to concentrate on the techniques of valuation, we assumed that we knew the discount rate or required rate of return. Here we consider it in detail because of its importance to any successful understanding of stocks. Chapter 14 builds on the themes developed in Chapter 8, where it was noted that investors often consider the investment decision as consisting of two steps, asset allocation and security selection. We are assuming here that the asset allocation decision has been made. Following the comparable chapter in the bond sequence (Chapter 12), the discussion of how investors should approach the analysis and management of stocks is divided into the two major alternatives, passive strategies and active strategies. This division is an effective and realistic way to organize this discussion, and once again allows the instructor flexibility in 14-1 bringing up such topics as Efficient Markets. The passive strategy discussion covers the buy-and-hold strategy and index funds. The active strategy discussion covers the major alternatives investors have in pursuing an active strategy--security selection, sector rotation, and market timing. This discussion is followed by a consideration of how Efficient Markets concepts affect active strategies, and opens up numerous possibilities for discussion....
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