Chapter 8

Share proportionally in dividends paid

Dividends are the periodic cash flow we use to value a share of stock. A firm will generally pay dividends on a quarterly basis. The management of the firm declares a dividend. It is totally up to them how much they want to pay, but usually firms try to keep their dividend stable. If a dividend is reduced if is often seen as a signal that the firm is having hard times and the stock price falls. After the dividend is declared, the firm sets an ex-dividend date- this simply means that they take a roll call of who all owns shares on that date. If you buy on or before that date then you will receive a dividend. If you buy the stock after that date then it is ex-dividend.

DPS

Dividends per share. Found as Total Dividends Paid/ Number of Shares The portion of EPS not paid out by the firm as a dividend is retained and thus gets added to RE.

EPS

Earnings Per share. Found: Net Income/ Number of shares

Non constant growth DVM

Growth is high for a number of years and then levels out. This is useful for valuing young firms that have not etched that mature stage.

Voting Rights

If you own a share of stock in a company, you are one of the company's owners. As such you get to vote for the board of directors and other important issues. Voting for directors may be straight (majority) voting or may be cumulative. -If it is majority voting: Then a shareholder receives one vote for each share of stock owned. -If it is cumulative: Then the shareholder receives one vote per share times the number of open board seats.

Share proportionally in any liquidation value

In the event of bankruptcy, a Trustee will generally be appointed to sell the companies assets and settle outstanding debts. After, bondholders, IRS, employees, etc. have all been paid in full, if there is an money left over, it will be distributed proportionally to all shareholders.

Cumulative Preferred Stock

Means that any dividends that are missed will ACCUMULATE. The company will have to pay all of these dividends in arrears before they are legally allowed to pay any dividend to the common stockholders. -Dividends do not become a liability of a firm until they are declared. So if the firm has no money for dividends they don't declare one. -Preferred dividends are locked in at a specific rate, like a coupon, and if they are missed then the preferred shareholders will expect to get the money in the future.

Over the counter market

No physical location- there is a network of dealers connected electronically.

Common stockholders

Owners- Lowest priority claim -For an investor, common stock is the riskiest investment because it represents a residual claim, meaning they get whatever is left after everyone else has been paid. -In the event of bankruptcy, the firm pays everyone else in FULL before the common stockholders get a penny.

Par Value

The face value of a stock. This doesn't affect our calculations on the market price. It is just an accounting number.

Paying Dividends

The firm that pays the dividend cannot deduct the dividend paid. Dividends are paid out of Net Income, meaning AFTER the firm calculates their tax liability. This is a big difference between the payment of interest on bonds and dividends on stock.

Initial Public Offering

This is primary market transaction in which a firm sells shares of stock to the "public" for the first time.

Book value of equity

This represents initial contributions (Par value and Additional Paid in Capital...meaning what the stock was sold to the public for) AND Retained Earnings. Historical measure.

Stock concepts

What exactly are stocks? They come from two perspectives (The Firm's and from investors) -Firm's standpoint: Stocks provide a way of raising money from investors by selling off little slices of the company. -Investors standpoint: It is the way of buying into a corporation. When investors purchase stock, they have a form of ownership in the company.

Preemptive Rights

When a company has to issue new stocks, current stockholders get first chance to buy the newly issued shares (pro rata) to avoid the dilution of their ownership control Some states give stockholders preemptive rights automatically, others don't.

Receiving Dividends

When an individual receives a dividend, they are taxed the following: -If an individual is in a relatively high tax bracket (ordinary income is taxed at 25% or higher, then dividends are taxed at a flat 25% (as capital gains) -If the individual is broke (or retired- meaning a low income tax bracket of less than 25%), then dividends are taxed at a flat rate of 5%. -When a corporation receives a dividend at least 70% of that dividend is exempt from taxation.

Understand the Constant Growth Dividend Valuation Model is just a present value problem!

it is nothing more than a slight tweak of the perpetuity formula. It is a GROWING perpetuity. The price (Po) is just the present value of all of the future cash flows ( which is the growing stream of dividends) -DVM works best for valuing firms that are relatively mature, stable earnings and divided payout rates, fairly stable industry.

Market Value of Equity

this represents the current market value. In other words, what the stock is worth. = Price Per share x Total # of shares

For investors: bonds less risky than preferred stock, which is less risky than common stock.

All has to do with residual income. -Bonds are the MOST risky and common stock is the LEAST risky (preferred in the middle). -Bonds are the most risky since if the firm misses a scheduled payment, they can force the firm into bankruptcy. -Preferred is next since although they can't force the firm into bankruptcy for missing a payment the firm WILL have to make good on all dividends in arrear (cumulative). -Common stock is the less risky because the firm is not obligated to pay the shareholders anything at all, as long as the firm pays off their bills.

Preferred Stock

Pays a dividend like common stock BUT the dividend is fixed. It is more like a coupon bond. -The firm will not be in default if they miss a dividend payment of preferred stock. So a preferred shareholder cannot force the firm into bankruptcy for a missed payment. -Generally purchased by companies not individuals. This is because of the tax provision that allows a company that receives a dividend to deduct 70% of the dividends received from their taxes. -Only valuable feature if preferred stock is the dividend.... more attractive to corporate buyers than to individuals.

New York Stock Exchange

an example of a physical market. this is a market (of exchange) at the corner of wall street and broad street. Specialist: Dealer for a security. They must be a NYSE member and are also known as a market maker. Manage their inventory by keeping a limit order book. Charged with maintaing an orderly market. Commission Brokers: these individuals execute customer orders to buy and sell stock on the floor of the exchange. Floor Brokers: NYSE members who execute orders for commission brokers. Floor Traders: these people trade of their own accounts, trying to earn a profit based upon price volatility. You must have a trading license.

NASDAQ

is an example of an over the counter market. No physical location, there is a interconnected network of dealers who compete by offering the most attractive bid and ask prices for shares in various securities.

Broker Market

is one where a broker matches buyers and sellers. They arrange a transaction but do not hold inventory. They earn a commission.

Dealer Market

is one where a dealer keeps an inventory and stands ready to buy or sell shares in certain stocks. The dealer will post a bid price (the price they are willing to pay you for your shares, so the price you can sell at) and an Ask Price: the price they are asking for shares you want to buy. One way a dealer makes money is the spread between the bid and the ask price. If a dealer makes a market in a well known- high liquid security then the bid-ask spread will be quite low.