Case Problem 6.1 Sara Decides to Take the Plunge

Sara Thomas is a child psychologist who has built a thriving practice in her hometown of Boise, Idaho. Over the past several years she has been able to accumulate a substantial sum of money. She has worked long and hard to be successful, but she never imagined anything like this. Even so, success has not spoiled Sara. Still single, she keeps to her old circle of friends. One of her closest friends is Terry Jenkins, who happens to be a stockbroker and who acts as Sara’s financial advisor.

Not long ago Sara attended a seminar on investing in the stock market, and since then she’s been doing some reading about the market. She has concluded that keeping all of her money in low-yielding savings accounts doesn’t make sense. As a result, Sara has decided to move part of her money to stocks. One evening, Sara told Terry about her decision and explained that she had found several stocks that she thought looked “sort of interesting.” She described them as follows:

·         North Atlantic Swim Suit Company. This highly speculative stock pays no dividends. Although the earnings of NASS have been a bit erratic, Sara feels that its growth prospects have never been brighter—“what with more people than ever going to the beaches the way they are these days,” she says.

 

·         Town and Country Computer. This is a long-established computer firm that pays a modest dividend yield (of about 1.50%). It is considered a quality growth stock. From one of the stock reports she read, Sara understands that T&C offers excellent long-term growth and capital gains potential.

 

·         Southeastern Public Utility Company. This income stock pays a dividend yield of around 5%. Although it’s a solid company, it has limited growth prospects because of its location.

 

·         International Gold Mines, Inc. This stock has performed quite well in the past, especially when inflation has become a problem. Sara feels that if it can do so well in inflationary times, it will do even better in a strong economy. Unfortunately, the stock has experienced wide price swings in the past. It pays almost no dividends.

 

Case Problem 6.2 Wally Wonders Whether There’s a Place for Dividends

Wally Wilson is a commercial artist who makes a good living by doing freelance work—mostly layouts and illustrations—for local ad agencies and major institutional clients (such as large department stores). Wally has been investing in the stock market for some time, buying mostly high-quality growth stocks as a way to achieve long-term growth and capital appreciation. He feels that with the limited time he has to devote to his security holdings, high-quality issues are his best bet. He has become a bit perplexed lately with the market, disturbed that some of his growth stocks aren’t doing even as well as many good-grade income shares. He therefore decides to have a chat with his broker, Al Fried.

During their conversation, it becomes clear that both Al and Wally are thinking along the same lines. Al points out that dividend yields on income shares are indeed way up and that, because of the state of the economy, the outlook for growth stocks is not particularly bright. He suggests that Wally seriously consider putting some of his money into income shares to capture the high dividend yields that are available. After all, as Al says, “the bottom line is not so much where the payoff comes from as how much it amounts to!” They then talk about a high-yield public utility stock, Hydro-Electric Light and Power. Al digs up some forecast information about Hydro-Electric and presents it to Wally for his consideration:

 

Year	Expected EPS ($)	Expected Dividend Payout Ratio (%)
2016	$3.25	40%
2017	$3.40	40%
2018	$3.90	45%
2019	$4.40	45%
2020	$5.00	45%

 

The stock currently trades at $60 per share. Al thinks that within five years it should be trading at $75 to $80 a share. Wally realizes that to buy the Hydro-Electric stock, he will have to sell his holdings of CapCo Industries—a highly regarded growth stock that Wally is disenchanted with because of recent substandard performance.

Case Problem 7.1 Some Financial Ratios Are Real Eye-Openers

Jack Arnold is a resident of Lubbock, Texas, where he is a prosperous rancher and businessman. He has also built up a sizable portfolio of common stock, which, he believes, is due to the fact that he thoroughly evaluates each stock he invests in. As Jack says, “You can’t be too careful about these things! Anytime I plan to invest in a stock, you can bet I’m going to learn as much as I can about the company.” Jack prefers to compute his own ratios even though he could easily obtain analytical reports from his broker at no cost. (In fact, Bob Smith, his broker, has been volunteering such services for years.)

Recently Jack has been keeping an eye on a small chemical stock. The firm, South Plains Chemical Company, is big in the fertilizer business—which is something Jack knows a lot about. Not long ago, he received a copy of the firm’s latest financial statements (summarized here) and decided to take a closer look at the company.

Cash$ 1,250

Accounts receivable$ 8,000Current liabilities$10,000

Inventory$12,000Long-term debt$ 8,000

Current assets$21,250Stockholders’ equity$12,000

Fixed and other assets$ 8,750Total liabilities and

Total assets$30,000stockholders’ equity$30,000

South Plains Chemical Company Balance Sheet ($ thousands)

Sales$50,000

Cost of goods sold$25,000

Operating expenses$15,000

Operating profit$10,000

Interest expense$ 2,500

Taxes$ 2,500

Net profit$ 5,000

Dividends paid to common stockholders ($ in thousands)$ 1,250

Number of common shares outstanding5 million

 

Recent market price of the common stock$ 25

Case Problem 7.2 Doris Looks at an Auto Issue

Doris Wise is a young career woman. She lives in Phoenix, Arizona, where she owns and operates a highly successful modeling agency. Doris manages her modest but rapidly growing investment portfolio, made up mostly of high-grade common stocks. Because she’s young and single and has no pressing family requirements, Doris has invested primarily in stocks that offer the potential for attractive capital gains. Her broker recently recommended an auto company stock and sent her some literature and analytical reports to study. One report, prepared by the brokerage house she deals with, provided an up-to-date look at the economy, an extensive study of the auto industry, and an equally extensive review of several auto companies (including the one her broker recommended). She feels strongly about the merits of security analysis and believes it is important to spend time studying a stock before making an investment decisions.

Case Problem 8.1 Chris Looks for a Way to Invest His Wealth

Chris Norton is a young Hollywood writer who is well on his way to television superstardom. After writing several successful television specials, he was recently named the head writer for one of TV’s top-rated sitcoms. Chris fully realizes that his business is a fickle one, and on the advice of his dad and manager, he has decided to set up an investment program. Chris will earn about a half-million dollars this year. Because of his age, income level, and desire to get as big a bang as possible from his investment dollars, he has decided to invest in speculative, high-growth stocks.

 

Chris is currently working with a respected Beverly Hills broker and is in the process of building up a diversified portfolio of speculative stocks. The broker recently sent him information on a hot new issue. She advised Chris to study the numbers and, if he likes them, to buy as many as 1,000 shares of the stock. Among other things, corporate sales for the next three years have been forecasted as follows:

Case Problem 8.2 An Analysis of a High-Flying Stock

 

Marc Dodier is a recent university graduate and a security analyst with the Kansas City brokerage firm of Lippman, Brickbats, and Shaft. Marc has been following one of the hottest issues on Wall Street, C&I Medical Supplies, a company that has turned in an outstanding performance lately and, even more important, has exhibited excellent growth potential. It has five million shares outstanding and pays a nominal annual dividend of $0.05 per share. Marc has decided to take a closer look at C&I to assess its investment potential. Assume the company’s sales for the past five years have been as follows: