Chapter 7: Stocks

Shareholder Voting

one vote per share, need a "super majority" (ex: 67%) for important matters such as sale of assets

Difference between NYSE & NASDAQ

1) NASDAQ is a computer network with no physical setting 2) NASDAQ uses multiple market makers rather than a single DMM. (No direct trading in the crowd).

Rights of Shareholders

1) vote proportionally for directors 2) share proportionally in dividends 3) share proportionally in assets remaining after liabilities have been paid in case of liquidation 4) vote on matters of great importance, such as a merger.

Why are stocks more difficult to value than bonds?

1)Cash flows are not known in advance 2) Life of the investment is essentially forever as there is no maturity 3) There is no way to know the rate of return the market requires.

Dividends

1. Dividends must be declared by BOD. Corporations cannot default on an undeclared dividend and cannot become bankrupt because of nonpayment of dividends. The amount of dividend and even whether it is paid are decisions for the board. 2. Dividends are not a business expense and are not deductible for corporate tax purposes. They are paid out of aftertax profits. 3. Dividends received by individual shareholders are taxable.

Forward PE ratio

A PE ratio that is based on estimated future earnings

Proxy Voting

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

classes of stock

A primary reason for creating dual or multiple classes of stock has to do with control of the firm. If such stock exists, management can raise equity capital by issuing nonvoting or limited-voting stock while maintaining control.

stated value

A stated liquidating value, usually $100/share. The cash dividend is described in terms of dollars per share.

Dividend Yield

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

NASDAQ Level 2

Allows user to view inside quotes . This access is available for a fee

Unpaid preferred dividends

Are not debts of the firm. Directors can defer preferred dividends indefinitely. Common shareholders also must forego dividends. Holders of preferred shares are often granted voting and other rights if preferred dividends have not been paid for some time. There is no interest on accumulated preferred dividends

Why is straight voting unlawful in some states?

Because it "freezes out" minority shareholders. However, corporations have worked out ways to minimize the impact.

comparables or comps

Can use PE ratio. (Price/EPS) So Price at Time t = Benchmark PE ratio x EPSt

How do you value stocks that do not have dividends?

Comparables is one way

constant dividend growth

Dividend at time t = D x (1+g)^t

Cumulative Dividend

Dividends not paid in a particular year, they are carried forward as an arrearage. Usually, both the accumulated (past) preferred dividends and the current preferred dividends must be paid before common shareholders can receive anything.

target prices

Forecast price a year from now. So if our earnings this year are $2 per share and our benchmark PE is 20, our share price today should be $40. However, if we think our EPS will be $2.50 next year, our target stock price will be $50 for a year from now.

NASDAQ Level 1

Freely available over the internet. Provides a timely accurate source of price quotation

NYSE members

Historically there were 1366 members who owned a seat on the exchange. Since 2006, instead of a seat, members must purchase trading licenses of which there are 1366 which entitles you to buy and sell securities on the floor of the exchange.

dividend growth model

If the dividend grows at a constant rate, g, and as long as the growth rate g, is less than the discount rate or required rate of return, R, then the present value (stock value) of a this series of cash flows can be written as: Po = [Do x (1 + g)] / (R - g) = D1 / (R - g) or at any given time, t: Pt = {Dt x (1 + g)] / (R - g) = Dt+1 / (R-g)

Components of Required Return (R)

If we rearrange our formula Po =D1/(R-g) and solve for R, we get: R = (D1/Po) + g

Supplemental Liquidity Provider (SLP)

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

designated market maker (DMM)

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

floor brokers

NYSE members who execute customer buy and sell orders

cumulative voting system

Permits minority ownership participation. If there are N directors up for election then 1/(N+1) percent of the stock plus one share will guarantee you a seat.

Staggered boards or "classified " boards

Staggers the election of board members so: 1) makes it more difficult for a minority shareholder to elect a director when there is cumulative voting (since the less directors up for election the more votes you need to guarantee a seat) 2) makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors.

preferred stock

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

non constant growth

This allows for "supernormal" growth for a period of time and then constant growth rate after. So you need to calculate the total value of a stock by adding the present value of each dividend to the present value of the stock when the dividends start having constant growth. See text page 212

How to value company with no earnings and no dividends?

Use the price-sales ratio. Which is Price per share divided by sales per share.

NASDAQ Level 3

Used be Market Makers Only. Allows them to enter or change price quote information.

zero dividend growth stock valuation

Value of stock = Dividend/rate of return This is essentially like a perpetual bond. P=D/R This is for companies who always pay out the same dividend.

Electronic communications networks (ECN)

Websites that allow investors to trade directly with one another. Allows individuals to be market makers and increased liquidity.

Trading in the crowd

When stock trades occur between floor brokers

straight voting

a procedure in which a shareholder may cast all votes for each member of the board of directors. Directors are elected one at a time. This guarantees a majority shareholder control of all the seats.

cumulative voting

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

proxy fight

develops when a group solicits proxies in order to replace the existing board

common stock

equity without priority for dividends or in bankruptcy

capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows (g).

order flow

the flow of customer orders to buy and sell securities

preemptive right

the right granting to shareholders the first opportunity to buy a new issue of stock. The purpose is to give stockholders the opportunity to protect their proportionate ownership in the corporation.