m3l3 - Fall 2011Module 3 Accounting & Finance Lecture...

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David Robinson © D. Robinson, 2011 Fall 2011Module 3 Lecture 3: Stocks, Portfolios, Mutual Funds & ETFs
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Accounting Finance Managerial Financial Auditing How investors use their money How firms raise money Three financial statements Forms of business Income St. Balance Sheet St. Cash Flows
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Lecture Outline Valuing Common Stocks The daily battle between greed and fear Long-run valuation of future cash flows Diversification Unique risk versus Market risk Portfolios Introduction to Mutual Funds and ETFs [Appendix: Price/Earnings Ratio]
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Common Stock (“shares”) A fraction of ownership in a company You can buy and sell at any time Company never expects to pay you back the original money Company _may_ give dividends (a small payment—part of the profits—typically once a year
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Common Stocks are Risky But, over long periods of time they give a better return than “fixed income investmestments” (i.e. bonds) Their rising prices reflect the growing economy
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Why do People Invest in Common Stocks ?
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All investors want a “good return” Interest rates on Savings Accounts at Banks are very low—about 1 percent Wouldn’t even keep up with inflation Total return: Price + dividends
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US Stocks are climbing back from a near- catastrophic sell-off in 2008-9 Low: early 2009, about 6,500 Peak 14,000 Oct 2007 End of Feb 2011, 12,130 (not all the way back) This summer, not so good: Oct 1: 10,913
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2008-9 was a classic “Bear Market”
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Definition: “Bear Market” A severe moderate-term decline in share prices The drop in prices causes a loss of investor confidence Many shareholders sell, decreasing prices further
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Over the long run, the market has returned 10.5 to 11 percent Total return: Price + dividends That beats “safe” bonds, say 4 to 5 percent Logarithmic scale
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Long-run Return of the Stock Market Decade Average annual return 1950s 17.62% 1960s 9.15% 1970s 10.45% 1980s 14.72% 1990s 18.54% 2000s
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Long-run Return of the Stock Market Decade Average annual return 1950s 17.62% 1960s 9.15% 1970s 10.45% 1980s 14.72% 1990s 18.54% 2000s 3.55% Hmm… Is it just an unlucky decade or a move to perpetual low returns?
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Valuing Common Stocks Common stocks produce a variable return
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Common Stock is even more risky than a corporate bond We hope to get a bigger return, But Dividends are not guaranteed If the company fails (goes bankrupt) we’ll likely get nothing at all [Bond holders (owners) are creditors of the firm and get paid in full before shareholders get what’s left.]
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Where do stock prices come from ? Book value? (Not likely) Remember, this ignores “going concern” value Value of the underlying assets (possibly) If we shut down and sell off all those depreciated assets Sophisticated investors “discounting” the expected future cash flows (earnings, not dividends) of the firm Long term Supply and demand in the market place, sentiment, “herding” Short term (the daily battle between greed and fear ) Remember this!
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greed and fear Is the stock worth $20.69 . . . or $20.32?
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m3l3 - Fall 2011Module 3 Accounting & Finance Lecture...

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