Chapter 12Chapter 12

Part 2

INDUSTRY

A group of companies producing similar products or services

Example: Soda

INDUSTRYCoca Cola

Pepsi

Jones Soda

Beverages

(non-alcoholic)

INDUSTRY

Beverages

(alcoholic)

• INDUSTRY S E C T O R

Beverages

(non-alcoholic)

Beverages

(alcoholic)

Consumer Non-Cyclical

Sector

not affected much by economy (ups & downs)

What Sector??

• General Electric

INDUSTRY

• A group of companies producing similar products or services

S E C T O R

• A broad group of similar industries

Today’s Topics

• What is diversification?

• Difference between Revenue & Profits?

• Importance of Earnings

• Dividends vs. Retained Earnings

• Income Stock

• Growth Stock

• Earnings per Share (EPS) & Price/Earnings

Diversification

• Reducing risk by combining different investments whose prices aren’t likely to move in step with one another

Technology

Financial Services

Capita

l Goo

ds Sec

tor

Healthcare Sector

Energy Sector

REVENUE (Sales)

Receive $10 at the end of the day

Is the $10 the person’s profit???

REVENUE (Sales)

• The $10 is the lemonade stand’s

revenue (sales)

• REVENUE – the total money a

company receives from selling a

product or service

REVENUE (Sales)

REVENUE PROFITS=

PROFIT (Earnings)

• The amount by which a company’s revenue exceeds its costs

R E V E N U E - C O S T S

P R O F I T S

PROFIT (Earnings)

R E V E N U E -- $10.00

- lemons, sugar,

cups (costs) 6.00

= P R O F I T $ 4.00

NET INCOME

• A company’s profit after subtracting all costs and income taxes

The Uncommon Hen & the Common Stock

MARIA

PIO

The Uncommon Hen & the Common Stock

Questions ?

1. Buyers bid against one another because they were eager to become Pio’s owner.

• What benefits did they initially expect to receive by becoming the chicken’s owner?

Response ?

• By owning Pio, they expected to earn money by selling all of the hen’s future golden eggs.

$

$$ $

$ $

Questions ?

1. Why did buyers suddenly lose interest in becoming Pio’s owner?

Response ?

• When Pio stopped laying golden eggs

• Buyers realized they could NOT earn money by owning the hen and selling its valuable eggs

Questions ?

1. Investors buy stock because they want to become part owners of a business.

• What benefits do investors expect to receive by becoming owners of the business?

Response ?

• Expect to receive company’s future earnings (profits)– Dividends– Higher stock price (capital gain)

Questions ?

• What would happen to the price of a stock if investors suddenly expected a company’s earnings to be much higher in the future?

Response ?

• Investors would bid up the price of the company’s stock

Questions ?

• What if suddenly they expected the company’s earnings to be much lower?

Response ?

• They would pay less for the stock

• It’s price will then fall

What does this chart suggest is the driving force

behind rising stock prices over the years?

Chart

• Driving force behind rising stock prices over time is rising profits or earnings

Lemonade Stand Example

• What if the lemonade stand’s costs add up to $12

Revenue $10.00

Costs - 12.00

L O S S - 2.00

L O S S

• The amount by which a company’s costs exceed its revenue

• No company is guaranteed a profit

• It has to earn it

• Many companies end up losing money instead

• Who bears a company’s loss??

• The company’s owners --– The stockholders

A Tale of Two Marts

Kmart and Wal-Mart

Kmart Sold everything for 5 - 10¢

1899 - S.S. Kresge Company1918 - sold stock to public to raise $1962 - grew larger and opened Kmart1977 - changed name to Kmart (earned all

profits)

A Tale of Two Marts

Wal-Mart

1962 - Start of Wal-Mart1970 - Became “Public”1980’s - Opened Sam’s Club1990 - nation’s largest retailer1997 – largest employer in U.S. (DOW)2002 - biggest business listed on Fortune 500

As earnings soared, so did it’s stock price

As earnings fell, so did it’s stock price

In 2002, Kmart declared bankruptcy.

Kmart

• May 2003 – Kmart emerges from bankruptcy

• January 2004 – earned first profit

• November 2004 - merged with Sears

Stock prices act as financial faucets in our economy

Increasing stock price opens flow of $ to company

Decreasing stock price slows flow of $ to company

Profits & Eggs

Profits & Eggs

Dividends

• Part of profits paid out to shareholders as cash or additional stock

Retained Earnings

• Part of profit that companies keep to reinvest in the company

– Buy new equipment, machinery, etc

– Research and development

Dividends & Retained Earnings

A portion of the company’s profit that is paid to shareholders

Company sells ---- 10,000. {sales}

--pays Expenses 7,500 {bills}

--pays Taxes 500

NET INCOME ----------2,000 {left over}

Dividends & Retained Earnings

Net Income $2,000.(profit)

3 Options: a) Retain and investb) Pay dividends to shareholdersC) Retain portion + pay out

portion

Tax on Profits $ .04

After tax $ .06

Before taxes $ .10

Dividends ~ $70 BRetained Earnings ~ $90 B

Total after-tax profits ~ $160 BDividends 2003 ~ $160BRetained Earnings 2003 ~ $290BTotal 2003 ~ $450 B

Dividend Yield 1.50%

$ .40 / 27.33 = $1.46

For over 40 years, the dividend yield on stocks has averaged 3.3%

• Some investors want a stock with strong dividend yields because they want the steady income the dividends provide

• Hence, INCOME STOCKS

• Many stocks offer small dividends, or no dividends at all

• These are usually smaller rapidly growing companies – they reinvest profits to help grow the business

• Shareholders hope to receive higher stock price increases

Growth stocks typically have above-average growth in earnings per share

Growth Stocks

• Usually have higher price/earnings ratios than the market in general

Stock Price = $20Earnings = $ 1

20

= 20

1

Growth Stocks

• The P/E shows how much you would have to pay for each dollar of the company’s latest earnings

• P/E will be higher if investors expect company’s profit to grow faster

Growth

• 1) Slowin Inc – slow growth expected

• 2) Growin Inc – phenomenal growth expected

P/E

• All P/E ratios are based on investors’ views of future earnings

1.51%

1.69%

3.12%

.93%

(.20 x 4) / 25. = .032 = 3.2%

.80 40

2.50 25

2.00 15

You want to buy a new car!

Price ? $34,000.

ASSET

• Something of value that a company holds

• You have $20,000 to put down -- need a loan for the balance

• Your loan would be D E B T

LIABILITY

• A debt that a company owes and must repay in the future

• If your loan (liability) is $14,000., what is the $20,000?? (the part you own)

• E Q U I T Y

EQUITY

• Ownership

BALANCE SHEET

• Summary of a company’s assets, liabilities, and equity

Assets = Liabilities + Equity

ACCOUNTING

• A method of recording a company’s financial story and arranging the information in reports that make the information understandable

ACCOUNTS PAYABLE

• The amount a company owes to suppliers for products and services bought

ACCOUNTS RECEIVABLE

• The amount customers owe a company for its products or services

CURRENT ASSETS

• Things that a company owns and could sell for cash during the year

CURRENT LIABILITIES

• The amount of a company’s debts payable within a year

DEPRECIATION

• The decline in value of an asset from wear and tear over a period of time, such as one year

DIVIDEND

• Part of a company’s profit (earnings) that it pays as money or shares to stockholders

Earnings Per Share (EPS)

• A company’s profit or earnings divided equally among all the shares investors own.

• It is calculated by dividing total earnings by the number of shares outstanding.

ENTREPRENEUR

• Someone who starts, manages, and bears the risks of owning a business

Financial Statements

• A company’s balance sheet and income statement

NET INCOME PER SHARE

• A company’s profit or earnings divided equally among all the shares investors own.

• It is calculated by dividing total earnings by the number of shares outstanding

PROPRIETORSHIP

• A company owned and run by one individual who receives its profits or bears its losses