FIN: Chapter 8: Stock Valuation

common stock

many different meanings, usually applied =to stock that has no special preference either in receiving dividends or in bankruptcy

When applying two-stage growth, in the second stage, g2

must be less than R

holders of preferred stock are often granted voting rights if preferred dividends have

not been paid for some time

The constant growth formula calculates the stock price

one year prior (year t) to the first dividend payment (Dt +1)

Preferred stock has preference over common stock in the

payment of dividends distribution of corporate assets

constant growth rate, the next dividend amount

D1 = D0 * (1 + g)

floor brokers

NYSE members who execute customer buy and sell orders

Which of the following occurs in the primary market?

Newly-issued stocks are initially sold

Using divided growth model to get the stock price at any point in time where Time is t

Pt = (Dt * (1 +g))/R-g = Dt/(R -g)

The dividend growth model calculates total return as:

R = Dividend yield + Capital gains yield or R = D1/P0 + g

classes of stock

created with unequal voting rights, reason has to do with control of the firm, if the stock exists management of a firm can raise equity capital by issuing nonvoting or limited-voting stock while maintaining control

If preferred dividends are _____ and are not paid in a given year, they will be carried forward as an arrearage.

cumulative

preference in stock means only the

holders of the preferred shares must receive a dividend before holders of common shares are entitled to anything sometimes have no voting rights

with nonconstant growth, it is important to notice when constant growth starts a common mistake is

incorrectly identify the start of the constant growth phase and as a result calculate the future stock price at the wrong time

many companies have staggered elections

only a fraction of directorships are up for election at a time

dividends

payments by a corporation to shareholders, made in either cash or stock

preferred stock

stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights

stated value

the amount per share assigned by the board of directors to no-par stock preferred shares

capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows growth rate g rate at which the stock price grows

the value of a share of common stock in a corporation is directly related to

the general rights of shareholders

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

when we say that the value of the stock is equal to the present value of the future dividends, we wont rule out the possibility that some number are zero

they cant all be zero

Stock market reporting has moved from print to

websites

Dusty Corporation has an issue of preferred stock that pays a dividend of 7 percent of its state value, which is $100. Which of the following would be a commonly used name for that preferred stock?

$7 preferred

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1-year return can be found using the formula

($84/$80) − 1

Shareholder rights

- Right to Evidence of Ownership - Right of Transfer - Right of Inspection - One share one vote - Right to Receive Dividends

share of common stock is more difficult to value in practice than a bond at least three reasons

-common stock not event he promised cash flows are known in advance -life of the investment is essentially forever because common stock has no maturity -there is no way to easily observe the rate of return that the market requires

three types of license holders

-designated market makers (DMM) -floor brokers -supplement liquidity providers (SLP)

staggering elections have two basic effects

-makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time -takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors

simplifying assumptions about the pattern of future dividends

-the dividend has a zero growth rate -the dividend grows at a constant rate -the dividend grows at a constant rate after some length of time

in addition to the right to vote for directors shareholders usually have the following rights

-the right to share proportionally in dividends paid -the right to share proportionally in assets remaining after liabilities have been paid in liquidation -the right to vote on stockholder matters to great importance, such as merger

important characteristics of dividends include the following

-unless a dividend is declared by the board of directors of a corporation, it is not a liability of the corporation, corporation cannot default on an undeclared dividend, as a consequence corporations cannot become bankrupt because nonpayment of dividends the amount of the dividend and even whether it is paid are decisions based on the business judgement of the board of directors -the payment of dividends by the corporation is not a business expense, dividend are not deductible for corporate tax purposes. in short dividends are paid out of the corporations after-tax profits -dividends received by individual shareholders are taxable

supplement liquidity providers

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

Which of the following are features of common stock?

It has no special preference in bankruptcy. It generally has voting rights. It has no special preference in receiving dividends.

designated market makers

NYSE members who act as dealers in particular stocks. Formerly known as "specialists"

WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No minority shareholder would have enough votes to win any seat on the board.

Is a company required to pay preferred dividends?

No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid.

Present value of a constant growth of cash flows equation

P0 = (D0 * (1 +g))/R-g = D1/(R -g)

present value of stock

P0 = (D1 + P1)/(1 + R) P) = current price of stock P1 = price in one period D1 = cash dividend paid at the end of the period R= required return in the market on this investment

Zero Growth Common Stock Equation

P0 = D/R

Two-Stage-Growth Equation

P0 = D1/ (r-g1) * [1-(1+g1/1+r)^t] + Pt / (1+R)^t

Stock Valuation for a company that doesn't pay dividends

Price at Time t = Pt = Benchmark PE ratio * EPS(subscript) t

Two-Stage-Growth Equation for time as t

Pt = Dt/ (r-g2) = (D0 * (1+g1)^1 * (1+g2)) / R-g2

DMM's post

a fixed place on the exchange floor where the DMM operates

proxy

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

dividend growth model

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

straight vote

a procedure in which a shareholder may cast all votes for each member of the board of directors, directors elected one at a time

cumulative voting

a procedure in which a shareholder may cast all votes for one member of the board of directors, total number of votes that each shareholder may cast is determined first (number of shares * number of directors to be elected)

nonconstant growth

reason to consider is allow for "supernormal" growth rates over some finite length of time, growth rate cannot exceed the required return indefinitely but can for some number of years, to avoid having to forecast and discount an infinite number of dividends we will require that the 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

Two-Stage Growth

special case of nonconstant growth, the dividend will grow at a rate of g1 for t years and then grow at a rate of g2 thereafter forever

The NYSE member who acts as a dealer in a small number of securities is called a(n)

specialist

he NYSE differs from the Nasdaq primarily because the NYSE ha

specialists an auction market a physical location

difference between bid and ask prices

spread

Two key differences between NYSE and Nasdaq

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

cumulative dividend

A feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends. not paid in a particular year they will be carried forward as an arrearage, most common

Zero Growth Common Stock

a share of common stock in a company with a constant dividend is much like a share of preferred stock, dividend on a share of preferred stock has zero growth and is constant through time

dividend yield

a stock's expected cash dividend divided by its current price D1/P)

electronic communications networks (ECN)

a website that allows investors to trade directly with each other

broker

an agent who arranges security transactions among investors

dealer

an agent who buys and sells securities from inventory

growing perpetuity

an asset with cash flows that grow at a constant rate forever

members

as of 2006, a member is the owner of a trading license on the NYSE, prior members were said to own "seats: and collectively members of exchange were also owners

preferred dividend is not like interest on a bond

board of directors may decide not to pay the dividends on preferred shares, decision may have nothing to do with current net income