Question

Your wealthy industrialist brother is trying to persuade your retired uncle to buy shares in puma Energy Limited which is listed on stock market? He himself owns a few thousand and is impressed by the steady rise in the price. Your uncle is skeptical because puma Energy pays out a very small dividend.Required:

(i)What arguments is your cousin likely to make to your uncle?

(ii)Are the arguments valid in this case?

Answer 1

(i) From the question it is clear that Puma Energy Limited is a growth stock. Growth stock refers to shares of those companies that use majority of their earnings to expand their business and generate more earnings. Thus cousin brother will point out following arguments to uncle as follows:

a) Investment in Puma Energy Limited will give price appreciation if held for longer period. It can double or even triple our investment.

b) Growth stocks are less sensitive to economic conditions

c) Growth stocks provide sustainability for your investment.

d) Growth stocks are less riskier compared to other stocks as they are tested and approved by arket.

e) Company earnings and reinvested in further expansion of business which will add further value appreciation of the company.

f) As the company has given value appreciation over the past years, it is hereby proved that company is indeed performing well.

g) Though the dividend payout is lower but you can exit any time when you get an ample amount of return from investment instead of waiting each quarter or year, as the case may be, for dividend payout.

h) Growth stocks will perform better in bull markets.

ii)

a) As uncle is a retired person and thus growth stocks are not suitable for his age group of investors. Instead of waiting longer period for capital appreciation they shoud focus on dividend stocks or bonds which would provide them with a steady amount of income each period. Dividend stocks will also appreciate in value and it will consistently pay dividends even when there is no capital appreciation.

b) Retired age group of investors normally have less risk tolerance and should not go for growth stocks as they may perform well in bull markets but can go opposite direction in bear market too which is highly risky as nobody can predict the market performance. Whereas dividend payout will happen even in bear market and these stocks are less volatile compared to growth stocks and offer stability and consistent cash flow.

Thus arguments of cousin brother will not be a better option according to him.