CARL WATTS & ASSOCIATES

July 05, 2010


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Securities -- Part 3
Stocks
TOP
I’d like to make the introduction to the stocks “episode” with a reference to the bonds one: when you buy bonds you make a debt investment in a company which guaranties to pay your money back (the principal) together with a promised interest.
When you buy stocks you make an equity investment, you become an owner of the public company’s shares, and as a shareholder you have a claim (no matter how small that may be) on the company’s assets and earnings; although they have voting rights, individual investors usually don’t own enough shares of a company to have a material influence on the company, it’s up to the institutional investors and the rich entrepreneurs to influence decisions about the company. But yours and the other investors’ claim on assets and earnings is what makes the stock worth a certain value.
At the same time stocks holders have limited liability which means that even if the company goes bankrupt you can only lose the value of your investment.
Having a claim on the company’s assets is only relevant in case of bankruptcy or liquidation. If the company does well and the value of the firm increases, you are entitled to a part of the profit which sometimes is paid out in the form of dividends, or achieved through stock appreciation in the open market.

There are two main forms of stocks:
Common Stocks represent the majority of stocks held by the public, the ones usually referred to when you hear or read about stocks being up or down. Investors have voting rights together with the right to share in dividends.
Common stocks are highly liquid and most of the larger companies trade daily on the stock markets.
Preferred Stocks confer fewer rights than common stocks, but investors are guaranteed fixed, consistent dividend forever. In case of liquidation, preferred shareholders are paid off before common shareholders. Also the company has the option to purchase shares from preferred shareholders for a number of reasons, usually for a premium.
Within a public company there are different terms used regarding shares, which imply different attributes:
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Authorized shares represent the total number of shares of stock authorized when the company was created. This number can be increased only by vote of the shareholders.
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Float shares are those shares actually available on the open market.
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Restricted shares are those used for employee incentive and compensation plans (for the insiders, as they re called).
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Unissued shares are retained by the company in its treasury.
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Outstanding shares represent the number of float and restricted shares together.
The ratio or relationship between these types of shares can tell investors useful information about a company’s policy and future trends. For instance, a company may retain a large percentage of shares as restricted and unissued shares to make sure no other company can seize control in an unwelcome takeover.

Or, if restricted shareholders submit plans to sell major blocks of stock, that may signal trouble inside the company.

Companies may also customize different classes of stocks usually with different voting rights, meaning a select group of shareholders could get a class of shares which gives them ten votes per share, instead of one. These classes are traditionally designated as Class A and Class B (the letter is placed behind the ticker symbol, which is the abbreviation used to identify publicly traded shares).
Investors usually classify stocks by type of business, so as to have similar industries together for comparison purposes. One of the most common classification breaks the market into eleven different sectors.
Two of the sectors are considered defensive, utilities and consumer stocks, because they can provide a cushion for the investor in a failing market.
The other nine sectors are called cyclical stocks and tend to react to a variety of market conditions; these sectors include basic materials, capital goods, communications, energy, financial, health care, technology, transportation, consumer cyclical. This kind of classification can help you as an investor compare how the stock you own or a stock you may want to buy is doing relative to other companies in the same sector.
Some companies distribute their profits to the shareholders through dividends in the form of cash and on occasions using stocks. Even though companies are under no obligation to pay a dividend, well established and profitable companies have a good history of paying dividends but may not offer much as growth potential.
The board of directors sets the dividend rate at a per share basis in quarterly meetings. Dividends are attractive to investors who are more interested in the current income.
If you want to find out more, please don’t miss our next episode about the Stock Exchange.