SIE Chapter 1: Equity Securities

Common stock is never issued as:

"callable"

Dividends are paid on:

1) Common stock 2) Preferred stock 3) Mutual fund shares 4) American Depositary Receipts (ADRs) *note: dividends are not paid on warrants or on bonds

Dividend Key Facts:

1) Corporations are not required to pay dividends (must be declared by Board of Directors) 2) Qualified Cash Dividends are fully taxable (Federal, State, and Local levels) · Generally taxed at 15% at the Federal level 3) Investors who are: · Long stock: receive dividends and stock splits · Short stock: owe dividends and stock splits 4) On the date that a corporation declares a cash dividend on common stock, it becomes a current liability on the balance sheet of the corporation 5) Dividends are normally paid to investors quarterly

Characteristics of preferred stocks:

1) Cumulative 2) Convertible 3) Participating 4) Callable

Types of REITs

1) Equity REITs 2) Mortgage REITs 3) Hybrid REITs

Reasons a company would repurchase its own stock:

1) Increase earnings per share 2) Finance future acquisitions (i.e. a stock for stock acquisition) 3) Provide stock for employee stock options plans 4) Fight a takeover attempt

Disadvantages of Limited Partnerships

1) Lack of liquidity · Limited partners may not sell their interest in the partnership back without restriction (unlisted) 2) Lack of control · Limited partners lack control over management (General Partner) 3) Tax code changes · Possible changes in the tax code, eliminating the tax advantage of such a transaction 4) Loss of investment · Loss of all or part of the investment 5) Assessment · Possible assessment of additional funds (oil and gas programs) 6) IRS scrutiny · Additional IRS scrutiny (abusive tax shelters) 7) AMT consequences · Potential Alternative Minimum tax consequences

When investors buy or sell stock, they will have either a:

1) Long position 2) Short position

Rights that common shareholders do NOT have:

1) NOT entitled to receive dividends 2) do NOT have the right to demand or vote on the dissolution of a company 3) do NOT have the right to vote for officers or senior management of the company

Advantages of DPPs

1) Taxation · Income and expenses flow through to the limited partners (Conduit Theory) · Single tax status · Files federal tax return, but does not pay federal income taxes · No double taxation of profits · Form K-1 are issued for tax purposes 2) Limited liability · Capital risk is normally limited to the investor's initial cash investment 3) Depreciation · Capital costs (e.g. buildings and machinery) can be depreciated) 4) Flexibility · DPPs have flexibility concerning the types of investments available 5) Diversification · Diversification of financial risk and professional management

Order of Asset Distribution upon Liquidation

1) Taxes 2) Secured Debt (generally bonds backed by assets) 3) Unsecured debt (debentures, general creditors) 4) Preferred stockholders 5) Common stockholders

Owning common stock gives the shareholder the right to:

1) receive a stock certificate (a record of ownership) 2) inspect certain corporate books of the corporation (generally balance sheet and income statement of company) 3) receive dividends 4) receive your proportionate share of the company's assets if the company is dissolved after more senior claims have been satisfied 5) vote for the members of the board of directors and on other important matters that affect shareholders 6) sell their shares

A normal round lot unit of trading for common stock is:

100 shares

Reverse Split

2:3 (Larger number last)

Regular Split

3:2 (Larger number first)

Rights generally have a maximum maturity of:

90 days

Registered Form

A certificate is issued in the shareholder's name and recorded on the company's books.

Equity Options

A contract that entitles the buyer to either buy or sell shares of underlying stock for a specific period at a set price.

Dividend

A portion of a company's net profit that is distributed by the company to its stockholders. Dividends are typically paid in cash but can be paid in the form of stock or property. Dividend payment types: 1) Cash (most common) 2) Company's own stock (stock dividend) · Shares of stock would most likely be paid as a dividend (stock dividend) by a company with a "small cash balance" 3) Stock owned of other corporations 4) Treasury stock (issued shares that have been repurchased) 5) Products

Due Bill

A statement of money owed. They are used between broker-dealers to adjust for incorrect dividend payments.

DPP Considerations

An investor purchasing an interest in a direct participation program should consider: · 1) The possible loss of principal · 2) The general partner's management ability and potential conflicts of interest between the general and limited partners · 3) Possible changes in the Federal Tax Code · 4) The projected rate of return · *note: the financial condition of other limited partners would not be a consideration in the customer's evaluation of a DPP

Limited Liability

As a common shareholder, investors cannot be held responsible for the unsatisfied claims of the corporation's creditors.

Equity security

Common stock is an _________ since shareholders have an equity (meaning ownership) position in the company.

Real Estate Investment Trusts (REITs)

Companies that manage portfolio of real estate properties to earn profits for their shareholders. Invests in: real estate (apartment and office buildings, nursing homes, and shopping centers) which produces revenue from rental income May: · Invest in long-term mortgages · Own real property · Make short-term real estate construction and development loans · Invest in other REITs

DERP Chart

D, R, P: set by corporation · Must own stock at least 1 business day prior to ex-date to get dividend E: Set by stock exchange or FINRA · Ex-date is 1 business day prior to record date for "regular way" transactions · Ex-date is 1 business day after record date for "cash" transactions

Regulation T Settlement

Federal Reserve Board regulation covering the extension of credit to customers. It requires that payment for purchases of securities must be received by the 4th business day after the trade date (T + 4).

Cyclical Stock

Heavily affected by normal business and economic cycles. Rise and decline along with the rise and fall in the economy Examples: · Auto manufacturers* · Steel companies · Appliance manufacturers · Housing companies · Paper companies · Tool and die manufacturers

Stock Split

Increases the number of outstanding shares of a corporation but does not change the proportionate equity ownership of shareholders. The ratio determines the number of new shares issued and the corresponding change in stock price. 1) Primary purpose is to increase the marketability of the stock by reducing the market price of the stock 2) Upon a stock split, investors will receive a new certificate for the additional shares they are entitled 3) Par value (face value) decreases proportionately to the split 4) Outstanding common shareholders must vote to approve stock splits 5) The capitalization of the corporation does not change with a stock split 6) When a publicly traded company does a stock split or pays a stock dividend, the transfer agent maintains an accounting of the shareholders who are entitled and not entitled to the split or dividend.

Dividends

Investors may receive a share of company profits while they own the shares (these are optional for the company)

Outstanding Shares Formula

Issued Stock - Treasury Stock = Outstanding Stock

Growth Stock

Issued by a company that is expected to have above-average increases in revenues and earnings Example: Amazon Characteristics · High percentage of retained earnings · Pay little or no dividend resulting in a low dividend yield and increases shareholder's equity · Generally have a high price/earnings ratio · Stock price may fluctuate widely and typically have high volatility · Emerging growth company is a fast-growing company with total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year. Generally high risk, high return, and high failure rates.

Defensive/Non-Cyclical Stock: (NOT defense industry)

Issued by a company that is resistant to normal business cycles and general stock market fluctuations. No significant increase or growth, but stable and consistent earnings year after year can be expected. Examples: · Tobacco companies · Utilities · Food companies · Pharmaceutical companies · Auto-repair companies Does not include steel companies, such as auto manufacturers or tool and die manufacturers

Common Stock

Issued by corporations to raise new capital to finance operations and ventures

Blue Chip Stock

Issued by nationally known company with a reputation for quality management, products, and services. · 1) Ability to pay dividends in good times and in bad times · 2) Many maintain 50% Dividend Payout Ratio, meaning they pay out half of their net profits in dividends Example: IBM

Other facts and characteristics of REITs

Low correlation to other financial assets · Real estate investments react differently (generally inversely) than stocks and bonds Traded OTC and on exchanges · If publicly sold, REITs must be registered with the SEC · Not exempt from registration

Authorized Stock

Maximum number of shares of stock allowed to be sold ("issued") as regulated by its corporate charter that is filed with the Secretary of State of the state of incorporation.

Capital Gain

Profit realized by selling shares for more than the amount paid for them.

Equity Security Derivatives

Securities that derive their value from the value of the underlying common stock Warrants: Always a WANT to Rights: Always a HAVE to Equity Options: Always a WANT to

Preemptive Rights Clause

Sets forth the requirement to offer existing shareholders preemptive rights upon the issuance of new shares

Regular/Statutory Voting

Shareholders receive one vote per share per director who is up for election. Shareholders may cast one vote per share either for or against each candidate for the board. However, no more than one vote per share may be given to any individual candidate. This method is most beneficial to large stockholders and is the most commonly used.

Cumulative/Block Voting

Shareholders receive one vote per share times the number of directors being voted on. They may cast their votes as a block for one candidate or may divide their votes in any manner desired. This is most beneficial to minority stockholders.

Subscription Rights: (Preemptive rights/"rights")

Short term privilege granted by a corporation to existing common shareholders which give them the opportunity to subscribe to a proportionate number of newly issued shares at a lower price than the public offering price before the public is allowed to purchase the new shares.

Special Situations

Stocks that are undervalued and their price can increase in value suddenly due to a number of reasons Some common reasons include: · New management · Introduction of a popular new product · Discovery of a natural resource on corporate property

Regular Way Settlement Date

The day on which a trade must be "settled" i.e. the buyer must pay and the seller must deliver the security that was sold. For common stock, settlement is 2nd business day after the trade date. (T + 2)

Rights Offering

The distribution of subscription rights to the existing common shareholders. In a Right Offering, existing shareholders receive one right for each share of common stock that they hold.

Current Yield on Common Stock

The measurement of the annual percentage rate of return you receive from investing in a stock. Also referred to as Dividend Yield. Annual Dividend/Market Price = Current Yield (%)

Countercyclical Stock

The opposite of cyclical stocks. Stocks that move in the opposite direction of the economy. Examples: · Gold mining companies* · Budget retailers (e.g. Walmart) · Temp agencies

Street Name

The security is registered on the issuer's books in the name of the broker-dealer that is holding the stock for the benefit of the customer (the "beneficial owner") and the broker-dealer keeps a record that it belongs to the customer.

Other characteristics of REITs

To qualify for tax exemption at the trust level IRS rules require that REITs... Payout at least 90% income to shareholders Have at least 75% assets in real estate related activities If REIT satisfies these requirements, the REIT avoids double taxation because REITs don't pay a corporate tax REITs can provide investors with: a) Income b) Diversification c) Growth d) Professional management No specific tax bracket or net worth is needed to invest in a REIT. No minimum investment requirements Income Equity Security · Investors in REITs generally seek income and capital appreciation · REITs do not provide investors with depreciation write-offs · Losses are not passed through to investors · Dividends paid are taxed at the individual's ordinary income tax rate REITs Earnings come from the difference between rental income and interest paid on borrowed money

Warrants

Traded separately from security issued with, meaning they are transferable Market premium = difference between the exercise price of the warrant and market price. At issuance warrants generally do not have any market premium meaning that initially the exercise price of the warrant is higher than the current market price of the stock (no intrinsic value) Most frequently issued with debentures (unsecured bonds) Issuance of warrants is always voluntary on the part of the issuer Exercising warrants causes dilution of the earnings per share on outstanding common shares. They do not protect investors from dilution. (Dilution means the total outstanding shares increase thereby decreasing the EPS) May be used as compensation for underwriters Dividends are NOT paid on warrants Mutual funds are allowed to put warrants into portfolios they manage

Utility Stocks

Utility companies provide electricity, gas, water, etc. to their customers. These stocks share unique characteristics including: a) Generally, offer above-average dividend yields, but less capital appreciation compared to growth stocks b) Highly leveraged (debt) because customers are dependent c) Changes in interest rates will have more of an effect on common stock 1) High level of debt means the high cost of operations (included interest costs) 2) Increase in interest rates cause an increase in operating costs for highly leveraged companies

Short Position

When an investor "borrows" stock from a broker-dealer and then sells the borrowed stock. These sellers attempt to make money by borrowing and then selling a company's stock at a high price and then later buying and replacing that amount of stock at a lower price. Investors that sell stock like this generally expect the market price of the stock to decline in price and are said to be "Bearish."

Long Position

When an investor "buys" and owns any security. These investors generally expect the market price of the security to go up in price and are said to be "Bullish."

o REITs Investing Advantages

a) Appreciation in property values b) Dividend income to investors c) Liquidity d) Increased demand for real estate e) Increase in occupancy of rental properties f) Managed by a Board of Trustees

Common stock has:

a) Been the best hedge against inflation and performs with the highest return during inflationary periods b) Had the greatest potential for long-term capital appreciation (greater than potential return than Preferred Stock and Bonds)

o REITs Risks or Potential Disadvantages

a) Decrease/weakening in demand for real estate b) Increase in interest rates, thus increase in mortgage rates c) Property developers overbuilding

Factors that negatively affect the overall economy typically negatively affect common stock:

a) Higher taxes b) Rising interest rates c) Decrease in GDP d) High unemployment

Factors that positively affect the overall economy typically positively affect common stock:

a) Lower taxes b) Lower interest rates c) Increases in GDP d) Low unemployment

Types of Stockholder Voting

a) Regular/Statutory Voting b) Cumulative/Block Voting

Treasury Stocks

a) do not vote b) do not receive dividends c) are not used in the Earnings Per Share (EPS) calculation d) appears on the balance sheet as a deduction from issued stock

Stockholder Voting

a) in person: by attending the corporation's annual stockholders meeting b) by proxy: shareholders can use an absentee ballot called a proxy

Cumulative

all dividends in arrears must be paid before common stockholders are paid a dividend (beneficial to investor/shareholder)

Issued Stock

amount of stock taken from authorized stock that is sold on "issued" to the public in a Primary Distribution. This amount is equal to or less than the amount "authorized" by the company.

Adjusted cost basis:

an investor's "cost" or "basis" in a partnership interest is increased and decreased by certain items and is then referred to as the "adjusted basis"

Preferred Stock

another type or "class" of stock a corporation can issue Equity Security: it is an equity security and represents ownership in the corporation "Preferred": priority over common stock in receiving dividends and sharing in assets if the corporation is dissolved Issuance: Companies generally do no issue more than one class or series of preferred stock, but would be allowed to do so 1) Equity Security: holders of preferred stock are owners and not creditors of the corporation 2) Fixed income security: the dividend is fixed 3) Pays a set dividend: stated as a % of par ($100) or in a fixed dollar amount for "no par" shares. Preferred stock may also pay a "variable" rate dividend. 4) No voting rights: usually no preemptive rights or voting privileges 5) Less volatile: generally, less volatile than common stock 6) Less appreciation: generally, offers less potential for appreciation than common stock

Payable Date

date that the dividend is actually paid · Dividends become a tax liability to the investor in the year the dividend is paid · This date also creates the taxable event for the investor.

Record Date

date the corporation closes the updating of the stock record book · Persons whose names appear on the book as of this date will be sent the dividend (right or wrong)

Declaration Date

date the dividend is declared by the Board of Directors

Ex-Dividend Date

date the stock begins to trade without the dividend · Normally the business day before the record date Exception: The ex-date for "cash" transactions is the business day after the record date

Shareholders who do not exercise their rights:

decrease their proportionate share of ownership in the corporation

Participating

dividends are fixed as to a minimum but not a maximum amount (beneficial to investor/shareholder) holders of participating preferred stock are entitled to their minimum dividend but have the right to participate with common shareholders in additional earnings distributions

The number of rights required to buy one new share of stock is calculates by:

dividing the number of outstanding shares by the number of new shares to be issued. (Outstanding shares/New shares = # of rights needed to purchase each new share)

Direct Participation Programs (DPPs)

investments which allow investors certain tax advantages. Limited partnership is the primary vehicle used for DPPs

Non-recourse loans

investor is NOT held personally responsible · Lender will accept the partnership property put up as collateral as payment for the loan in the case of a default.

Recourse loans

investor is held personally responsible · Highly leveraged DPPs (a lot of debt) usually have recourse loans

At risk investment

investor's initial cash investment plus any recourse loans

Adjusted basis

is important to a limited partner because limited partners can never write-off more than the adjusted basis

Mortgage REITs

lend money to building developers and pass the interest income on to shareholders · Are generally highly leveraged (i.e., their capital structure has a high amount of debt in relation to equity)

An odd lot unit of trading for common stock is:

less than 100 shares

Limited partners

limit their liability to the amount of their "at risk" investment in the entity

Shareholders who exercise their rights:

maintain their proportionate share of ownership in the corporation

General partners (sponsor - manager):

manage the entity and have unlimited liability

Convertible

may be converted into common stock at the option of the stockholder (beneficial to investor/shareholder) Market price of convertible fluctuates more than other types of preferred stock even with stable interest rates because it will try to maintain patiry (equal value) with the common stock. Conversion will increase the number of common shares outstanding and dilute the earnings per share.

Hybrid REITs

mix of equity and mortgage REITs

American Depository Receipts (ADRs)

o Receipts traded in the US for foreign stocks held in bearer form by an American bank in foreign country. An ADR can represent a ratio or fractional ownership of the foreign ordinary shares. · No voting privilege · Dividends are paid in US Dollars, not the foreign currency · Taxed as a security and gains and losses are reported on IRS Form 1099b · Not used as callable

Market Value

price a stock can be sold in the open market. It is determined by supply and demand. A stock does not have a fixed market value. At any moment, it's only as valuable as people think it is. Therefore, it fluctuates in daily value in the market.

Treasury Stock (Repurchased Stock)

results when a company repurchases its own outstanding common shares in the open market. The Board of Directors makes this decision to repurchase shares.

Outstanding Shares

shares of a corporation's stock that are issued and held by stockholders. Only shares which: a) Vote b) Receive dividends c) Are used to calculate Earnings Per Share

Par Value

stated fixed value printed on the face of the stock certificate. It has little to no relevance for investors. Many new issues are issued as "no par value" common stock.

Equity REITs

take equity positions in real estate · Shareholders receive income (from rents received) and capital gains when the property is sold at a profit.

Trade Date

the date on which a buy or sell order is executed

Reverse Split

the opposite of a stock split AKA stock consolidation Decreases the number of outstanding shares 1:2 Trouble sign: a reverse split can be a sign of trouble with a company Par value: increases proportionately to the reverse split

Callable

these may be redeemed (called) by the issuer at a set premium over the par value, after a specified date. Most preferred stock is callable. (beneficial to the company/issuer of stock)

Point of Stock

used when discussing changes in stock price. 1 _____ is equal to $1.

Increased adjusted basis:

· Additional contributions by the partner · Partnership income

Decreased adjusted basis

· Distributions of property (including cash) to the partner by the partnership · Partnership losses · Non-deductible partnership expenses · Depletion deductions for oil and gas partnerships

REIT Index ETF

· Investing in a REIT Index ETF would increase an investor's diversification in the real estate sector · Fund invests in many REITs rather than just one

Private REITs

· Not traded on a National Exchange or Registered with the SEC · As a result, Private REITs are not subject to the same disclosures as Public REITs

REITs are NOT:

· Redeemable · Investment companies · Regulated under the Investment Company Act of 1940 · Direct participation programs or limited partnerships

Rights holders may:

· Subscribe to: use rights to subscribe to (purchase) additional shares · Sell: sell their rights · Expire: let their rights expire · Gift: gift the rights to another investor Note: shareholders may not redeem the rights for cash with the corporation