1. Assuming that the stock actually splits two for one, how many shares will Pete and Jessica own? What will be the market value of their stock after the split? How will the split affect the value of their holdings? Was their next-door neighbor correct in thinking that the stock split made the stock a "real money maker"?
2. Using the information provided, calculate the stock's P/E ratio. Would you classify this investment as a growth or value stock?
3. Since Pete, in particular, is worried about the price of the stock, explain to him how and why corporate earnings are so important in the valuation of common stocks.
4. Should Pete and Jessica be using the S&P 500 Index as a benchmark for this stock? Why or why not? What benchmark recommendation would you make?
5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a "no-lose guarantee." Should they invest with this type of broker?
6. Name at least five things Pete and Jessica need to look out for when making stock investments.
Pete and Jessica, on the advice of their next-door neighbor, recently purchased 500 shares of a small-capitalization Internet stock, trading at $80 per share. Their neighbor told them that the stock was a "real money maker" because it recently had a two-for-one stock split and would probably split again soon. Even better, according to the neighbor, the company was expected to earn $1 per share and pay a $0.25 dividend next year. Pete and Jessica have so far been less than impressed with the stock's performance—the stock has underperformed the S&P 500 Index this year. Pete and Jessica have come to you for some independent advice.