Chapter 7

Supernormal growth

dividend growth is not consistent initially but settles down to constant growth eventually

As with bonds, the price of the stock is the present value of these expected cash flows

dividends → cash income, selling → capital gains

What is one of the primary factors that we look at when attempting to value common stocks

the dividends currently being paid

With corporate democracy what prevails absolutely

the golden rule

preemptive right

the right to share proportionally in any new stock sold, this is also a right that shareholders sometimes have

is it more common that there is a crowd around these posts for that there's no one around these posts

no crowd

One ____ one ______, NOT

one share one vote, NOT one shareholder one vote

preferred stock

stop that has preference over common stock in the payment of dividends and in the distribution of Corporation Assets in the event of liquidation

If you are doing this for multiple years of dividends you do

that formula for each year and add together ((D1..2..3..) / (1 + R)^1..2..3)

If you own a share of stock, you can receive cash in two ways

the company pays dividends, you sell your shares either to another investor in the market or back to the company

Proxy

the grant of authority by a shareholder to someone else to vote that shareholders shares, for convenience much of the voting in large public corporations is actually done by proxy

The price of the stock today is equal to

the present value of all future dividends (but we do not rule out the possibility that some number of those dividends are zero)

You could continue to push back when you would sell the stock and you would find that

the price of the stick is really just MISSED

PE ratio

the ratio of a stock's price per share to its earnings per share (EPS) over the previous year, we can use this to evaluate stock when a company does not pay dividends

If the constant growth rate exceeded the discount rate

the stock price is infinitely large because the present value of the dividends keeps increasing

what is the distinctive feature of Corporations

they have shares of stock on which they are authorized by law to pay dividends to their shareholders

what happened to NASDAQ in 2007

they merged with the OMX group

What is the main reason to consider the case of nonconstant growth

to allow for supernormal growth rate

The spread

the difference between the bid and ask prices, it is the basic source of dealer profits

Straight voting process

the directors are elected one at a time, the only way to guarantee a seat is to own 50 percent plus one share which also guarantees that you will win every seat, this can "freeze out" minority voters

order flow

the flow of customer orders to buy and sell stuff

The effect of cumulative voting

to permit minority participation

electronic communications Networks

websites that allow investors to trade directly with one another

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

with common stock not even the promised cash flows are known in advance, the life of an 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

Can directors elected by the common shareholders defer preferred dividends indefinitely

yes

Member

The owner of a trading license, or a "seat", on the NYSE ( New York Stock Exchange)

what is the average time for a trade on the NYSE Arca

1 second

Staggered elections

only a fraction of the directorships are up for election ar a particular time

What would be some reasons the preferred stock is really debt in disguise

preferred shareholders are only entitled to receive a stated dividend, often preferred stocks carry credit ratings much like those of bonds, preferred stock is sometimes convertible into common stock preferred stocks are often callable, in addition many new issues of preferred stock have had obligatory sinking funds

If C1 is the next cash flow on a growing perpetuity, then the present value of the cash flows is given by

present value = C1 / (R- g) = C0 (1 + g) / (R- g)

primary Market

shares of stock are first brought to the market and sold to investors

Classes of stock

some firms have more than one class of common stock and they are created with unequal voting rights

Common stock

stock that has no special preference either in paying dividends or in bankruptcy

Capital gains yield

the + g part of the formula, the rate at which the value of the investment grows

Dividend growth model formula

(dividend just paid OR dividend of year you are trying to find x (1 + g) ) / (R - g)

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

what are three important 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. the payment of dividends by the corporation is not a business expense 3. dividends received by individual shareholders are taxable

what are the two main differences between the NYSE and the 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

What are the two basic effects of Staggering

1.) it makes it more difficult for a minority shareholder to elect a director when there is cumulative voting 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

when was the New York Stock Exchange founded

1792

Formula used for stock valuation using comparables

Pt = benchmark PE ratio x (earnings per share)t

What is the largest stock market of the world

the New York Stock Exchange, popularly known as the big board

Dividend yield

D1 / P0, expected cash dividend / current price

Cumulative voting process

The total number of votes that each shareholder may cast is determined first, this is usually calculated as the number of shares ( owned or controlled ) * the number of directors to be elected, the directors are elected all at once

Forward PE ratio

a PE ratio based on estimated future earnings

dividends paid to shareholders represent

a return on the capital directly or indirectly contributed to the corporation by the shareholders

designated market makers (DMMs)

active dealers in particular stocks, typically each stock is assigned to a single DMM, they maintain a two-sided Market meaning that they continually post updates of bids and ask prices, this ensures that there is always a buyer or seller available there by promoting Market liquidity

Growing perpetuity

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

preferred stock is a form of

equity, however these stockholders may not have voting privileges

floor broker

execute trades for customers with an emphasis on getting the best price possible, are typically employees of large brokerage firms, the interaction between them and DMMs are the can you tune an electric trading on the NYSE

secondary Market

existing Shares are traded among investors

Constant dividend growth

firm will increase by the dividend by a constant percent every period, formula is = dividend just paid x (1+g)^t

Constant dividend/zero growth

firm will pay a constant dividend forever, like preferred stock, price is computed using the perpetuity formula (dividend/discount rate)

In what case would holders of preferred shares be granted voting and other rights

if preferred dividends have not been paid for some time

proxy fight

if shareholders are not satisfied with management an outside group of shareholders can try to obtain both via proxy, they can vote by proxy in an attempt to replace management by electing enough directors

Do exact mechanisms for electing directors differ across companies, if yes what is the most important difference

yes, whether shares must be voted cumulatively or voted straight

a small number of NYSE members are

Floor Traders who independently trade for their own accounts, they try to anticipate temporary price fluctuations and profit from been buying low and selling High

The benchmark PE ratio comes from

based on similar companies or on a company's historical values

are unpaid preferred dividends debts of the firm

no

DMM's post

Each of the counters on the floor are a post, DMM's operate in front of their post to Monitor and manage trading in the stock assigned to them

With cumulative voting, if there are N directors up for election, then _____ percent of the stock plus one share will guarantee you a seat

1 / (N + 1)

Why are staggered boards often called classified boards

Because directors are placed into different classes with terms that expire at different times

How would you find the required return

R = D1 / P0 + g

The dividend growth model calculates the total return as

R = dividend yield + capital gains yield

Preference

The holders of the preferred shares must receive a dividend in the case of an ongoing firm before holders of common Shares are entitled to anything

The conceptual structure of the corporation

assumes that shareholders elect directors who, in turn, hire management to carry out their directives, therefore they control the corporation through the right to elect the directors

How are directors elected

at an annual shareholder's meeting by a vote of the holders of a majority of shares who are present and entitled to vote

the business of the NYSE is to

attract and process order flow

The next dividend for the gordon growth company will be $4 per share. Investors require a 16 percent return on companies such as Gordon. Gordon's dividend increases by 6 percent every year. Based on the dividend growth model what is the value of Gordon's stock today? What is the value in 4 years

because D1 is given as the NEXT dividend, it is not multiplied by (1 + g) so it would be $4/(.16 - .06) TO FIND THE VALUE NOW, when finding in four years the formula is normal but to find what to plug into D4 you do D1 x (1 + g)^3 which comes to $4.76

before the common shareholders can receive anything

both the accumulated preferred dividends and the current preferred dividends must be paid

Broker

brings buyers and sellers together but does not maintain an inventory

if preferred Dividends are cumulative and are not paid in a particular year they will be

carried forward as a arrearage

what is typically worn by many of the people on the floor of the exchange and what does it indicate

colored coats which indicates the person's job or position

are most dividends payable on preferred stock and cumulative or non-cumulative

cumulative

what are the three types of license holders

designated market makers (DMMs), floor brokers, and supplemental liquidity providers (SLPs)

If you know how much the stock will be worth in the future, how do you get the current value

discount the price back: future value / (1 + r)^t

Constant growth model conditions

dividend expected to grow at g forever, stock price expected to grow at g forever, expected dividend yield is constant, expected capital gains yield is constant and equal to g, expected total return R must be >g, expected total return (R): = expected dividend yield (DY) + expected growth rate (g) = dividend yield + g

Target prices

if your earnings turn out to be $2.50 then the stock price one year from today should be $50 (20 x $2.50), target prices are forecast prices like this

NASDAQ Market

in terms of the number of companies listed and on many days the number of shares traded it is even bigger than the NYSE, it is a computer network of Securities dealers who disseminate timely security price quotes to NASDAQ subscribers

supplemental liquidity providers (SLPs)

investment firms that agree to be active participants in stocks assigned to them, they regularly make a one-sided market and trade purely for their own accounts so they do not represent customers, they do not operate on the floor of the stock exchange

why is the New York Stock Exchange unique

it is a hybrid Market meaning that trading takes place both electronically and face to face

What beneficial purpose may staggering provide

it provides institutional memory which is continuity on the board of directors, this may be important for corporations with significant long-term plans and projects

what are the three levels of information access in an NASDAQ network

level 1: Designed to provide a timely accurate source of price quotations, 2: allows users to view price quotes from all NASDAQ market makers, 3: for the use of market makers only, allows dealers to enter or change their price code information

Dealer

maintains an inventory and stands ready to buy and sell at anytime