Econ 135

Front 1

Financial fragility

Back 1

 Over time, an increasing amount of debt is piled into a given amount of equity, thus increasing the vulnerability to financial risk.
 Example: Lehman Brothers: debt-to-equity ratio is over 30 times

Front 2

Capital Gain tax

Back 2

 Now it is 15% for stocks that are held for more than one year.
 ________ locks people into existing investment
 Some industries like real estate allows selling a property and buying another without paying capital gains tax
 In California, capital gains are treated as ordinary income
 Capital gains are not adjusted for inflation, and thus tax “phantom” income

Front 3

Market Capitalization (market cap)

Back 3

 (Number of Outstanding Shares) * (Price per Share)
 as a measure of the “size” of the company

Front 4

Mega-Cap stock

Back 4

 More than $50 billion in market cap

Front 5

Large-Cap stock

Back 5

 More than $10 billion in market cap
 Mega cap: very big companies, e.g. GE, MSFT

Front 6

Mid-Cap or Median Cap stock

Back 6

 $2-10 billion market cap

Front 7

Small Cap stock

Back 7

 Under $2 billion but bigger than micro-cap (see below)

Front 8

Micro Cap stock

Back 8

 Under $500 million

Front 9

Dow Jones Industrial Index

Back 9

 a price-weighted average of 30 mega-cap stocks traded on the New York Stock Exchange and the Nasdaq.
 invented by Charles Dow in 1896

Front 10

S&P’s 500 Index

Back 10

 a market cap-weighted stock market index of 500 large cap US stocks traded in the US stock exchanges.
 The index covers more than 80% of the total market cap of the US market
 It is the benchmark of US stock markets used by most investment professionals

Front 11

S&P’s 400 Index

Back 11

 A stock market index for mid cap companies, with companies of market cap $750 million to $3.3 billion

Front 12

S&P’s 600 Index

Back 12

 A stock market index for small cap companies, with companies of market cap $300 million to $2 billion

Front 13

Nasdaq Index

Back 13

 Nasdaq stands for National Association of Securities Dealers Automated Quotations
 The index has about 3200 companies. As many companies in this index belong to the technology sector, this index is often regarded as a benchmark index for technology stocks.

Front 14

Russell 1000, 2000 and 3000

Back 14

 The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It includes 1000 companies of the largest market cap. The index represents about 92% of the U.S. market.
 The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It represents about 10% of the total market cap of US market
 The Russell 3000 Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the U.S. market.

Front 15

Defined Benefit Plan

Back 15

 A retirement plan that guarantees pension based on number of years’ work and average salary (usually the last three years)
 Some companies (e.g. General Motors) have offered many of these schemes to their workers, and now these companies suffer

Front 16

Defined Contribution Plan

Back 16

 A retirement plan such that individual workers invest parts of their salaries (often partly matched by companies) and decide how funds will be invested (usually mutual funds or similar funds)
 Examples: 401K (for-profit companies), 403B (non-profit or educational institutions)

Front 17

PE ratio

Back 17

 = stock price divided by EPS.
 In principle, the EPS used should be prospective EPS, but this relies on forecasts, which may not be accurate. Some financial websites just show PE based on historical EPS, e.g. trailing 12-month EPS.
 Why such a ratio? Just stock price is not enough. We have to compare it with a benchmark (e.g. EPS, BV)
 Low PEs usually reflects poor business or growth prospect. High PEs usually reflects a strong growth prospect.

Front 18

Price Book ratio

Back 18

 = stock price / book value
 A company with a low price-book ratio may be an under-valued stock. However, it may also mean something severely wrong about this company.
 Investors of value stocks usually look for stocks with a low price-book ratio.

Front 19

Beta

Back 19

 A measure of a stock’s volatility relative to that of the overall market (S&P 500)
 Beta =1: volatility same as the overall market
 Beta < 1: volatility smaller than overall market
 Beta > 1: volatility larger than overall market

Front 20

Earnings Yield (on S&P 500 Index)

Back 20

 = Current operating earnings of S&P 500 companies/ Value of S&P 500 Index
 An indicator about the valuation of the overall US stock market.
 Historically, average PE approximately = 14.45
 Average historical earning yield approximately = 6.8% (= 1/14.45)

Front 21

Fed Model

Back 21

 This model believes that returns on long-term government bond yields should be similar to the S&P 500 earnings yield. Differences in these returns identify an over-priced or under-priced securities market.
 Earnings yield much greater than LT govt. bond yields  stocks undervalued
 Earnings yield much smaller than LT govt. bond yields  stocks overvalued
 Now, PE ratio of S&P 500 index is about 15
 Therefore, earnings yield is about 6.7% (=1/15)
 LT govt. bond yield is about 3.8-4.5%
 Therefore, stocks are quite undervalued relative to LT govt. bonds.
 Note: The Fed doesn't endorse this tool. In fact, it was named the "Fed model" by Prudential Securities strategist Ed Yardeni.

Front 22

Dogs of the Dow Strategy

Back 22

 It is a stock picking strategy devoted to selecting high dividend stocks.

Front 23

Growth Stocks

Back 23

 Companies increasing revenues and profits at a rapid rate
 Note: the textbook definition is companies with high PE and price-book ratios. This definition is WRONG.

Front 24

Portfolio Allocation

Back 24

1. %depends on risk tolerance & age
2. stock broker& investment advisory often have a "normal" allocation
ex. stocks 60%
bonds 30%
cash 10%

Front 25

cyclical bull market

Back 25

occurs during course of bus. cycle

Front 26

secular bull market

Back 26

occurs many years