Finance Ch. 8 - Stock Valuation

Differences between NASDAQ and NYSE

1. NASDAQ is a computer network and has no physical location where trading takes place 2. NASDAQ has a multiple market maker system rather than a DMM system

Order Flow

Flow of customer orders to buy and sell securities

Designated Market Maker (DMM)

NYSE members who act as dealers in particular stocks. Formerly known as "specialists" Typically each stock on the NYSE is assigned to a single DMM DMM maintains a two sided market meaning that he or she continually posts and updates bid and ask prices

Preferred Stock

Stock with dividend priority over common stock. Normally with a fixed dividend rate, sometimes without voting rights Holders of preferred shares must receive a dividend before holders of common shares

Zero Growth

Much like a preferred stock, dividend on a share of preferred stock has a growth of zero and is constant through time P0 = D/R

Classes of stock

Some firms have more than one calss of common stock and often the classes are created with unequal voting rights

Dividend Yield

A stock's expected cash dividend divided by its current price D1/P0

Broker

An agent who arranges security transactions among investors

Dealer

An agent who buys and sells securities from inventory Maintains an inventory and stands ready to buy and sell at any time

Constant Growth

An asset with cash flows that grow at a constant rate forever is called a growing perpetuity P0 = D1/(R-g) aka Dividend Growth Model

Member

As of 2006, a member is the owner of a trading license on the NYSE

Common Stock

Equity without priority for dividends or in bankruptcy

Valuation using multiples

For stocks that don't pay dividends (or have erratic dividend growth rates) we can value them using the PE ratio and/or the price sales ratio: Pt = Benchmark PE ratio = EPS(at time t) Pt = Benchmark price-sales ratio x Sales per share(at time t)

Proxy

Grant of authority by a shareholder allowing another individual to vote his or her shares

Cumulative and Noncumulative Dividends

If preferred dividends are cumulative and are not paid in a particular year, they will be carried forward as an arrearage Accumulated and current dividends must be paid before the common shareholders can receive anything Unpaid preferred dividends are not debts of the firm

NASDAQ Networks

Level 1 - provide a timely, accurate source of price quotations Level 2 - allows users to view price quotes from all NASDAQ market makers (inside quotes) Level 3 - for Market Makers only. This access level allows NASDAQ dealers to enter or change their price quote information

NASDAQ's 3 Separate Markets

NASDAQ Global Select Market - lists about 1200 companies including some of the best known companies in the world NASDAQ Global Market - somewhat smaller in size, 1450 listed NASDAQ Capital Market - 650 currently listed

Floor Broker

NYSE members who execute customer buy and sell orders Generally employees of large brokerage firms such as Merrill Lynch (wealth management of BofA)

Staggering elections

Only a fraction of directorships are up for election at a particular time 1. Staggering makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time 2. Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors Staggering provides a institutional memory - continuity on the board of directors

Dividends

Payments by a corporation to shareholders, made in either cash or stock Represent a return on capital directly or indirectly contributed to the corporation by shareholders

Stated Value

Preferred shares have a stated liquidating value usually $100 per share Cash dividend is described in terms of dollars per share i.e. "$5 preferred" easily translates into a dividend yield of 5% of stated value

Two Stage Growth

Special case of nonconstant growth: 2 stage growth Dividend will grow at a rate of g1 for t years and then grow at a rate of g2 thereafter forever there is a P0 and a Pt equation, first solve for Pt and then plug into the P0 equation to get the value of the stock

Preemptive Right

Stockholders sometimes have the right to share proportionally in any new stock sold

Capital Gains Yield

The dividend growth rate, or the rate at which the value of an investment grows This is because the dividend growth rate is also the rate at which the stock price grows

Inside Quotes

The highest bid quotes and the lowest ask quotes for a security

Primary Market

The market in which new securities are originally sold to investors

Secondary Market

The market in which previously issued securities are traded among investors

Characteristics of Dividends

1. Unless a dividend is declared by the board of directors of a corporation, it is not a liability of the corporation 2. Payment of dividends by the corporation is not a business expense. Dividends are not deductible for tax purposes 3. Dividends received by individual shareholders at taxable

DMMs Post

A fixed place on the exchange floor where the DMM operates

Dividend Growth Model

A model that determines the current price of the stock as its dividend next period divided by the discount rate less the dividend growth rate

Straight Voting

A procedure in which a shareholder may cast all vote for each member of the board of directors

Cumulative Voting

A procedure in which a shareholder may cast all votes for one member of the board of directors

Supplemental Liquidity Providers (SLPs)

Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (offering either to buy or sell). They trade purely for their own accounts

Other rights of Shareholders

In addition to the right to vote for directors, shareholders usually have the following rights: 1. The right to share proportionally in dividends paid 2. The right to share proportionally in assets remaining after liabilities have been paid in a liquidation 3. The right to vote on stockholder matters of great importance such as a merger. Voting is usually done at the annual meeting or a special meeting

Components of the Required Return

R = Dividend Yield + Capital Gains Yield R = D1/P0 + g

Nonconstant Growth

Requires that dividends start growing at a constant rate sometime in the future

Over the Counter (OTC) Market

Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories