CHAPTER 11• Common stock holders are really the residual owners of the company. Residual owners, holders of common stock have no guarantee that they will receive any return on their investment.THE APPEAL OF COMMON STOCK• Common stocks remain a popular investment choice among both individual and institutional investors. • Many stocks do pay dividends, thereby providing investors with a periodic income stream.• When the market is strong, investors can generally expect to benefit from steady price appreciation.FROM STOCK PRICES TO STOCK RETURNS• Stock returns are important to investors, which take into account both price behavior and dividend income.THE PROS AND CONS OF STOCK OWNERSHIPAdvantages:• Substantial return opportunities they offer.• Generally provide attractive, highly competitive returns over the long haul.• Typically outperform bonds• Provide investors protection from inflation because over time their returns exceed the inflation rate. In other words, by purchasing stocks, investors gradually increase their purchasing power over time.• They are easy to buy and sell, and the transaction costs are modest.• Price and market information is widely disseminated in the news and financial media.• The unit cost of a share of common stock is usually within the reach of most individual investors.• Don’t have high minimums, most today are priced at less than $50 or $60 a share.Disadvantages:• Risk is most significant. It can affect a stock’s earnings and dividends, its price appreciation, and, rate of return earned by investor.- Business and financial risk- Purchasing power risk- Market risk- Event risk• The earnings and general performance of stocks are subject to wide swings, so it is difficult to value common stocks and consistently select top performers.• The sacrifice in current incomeBASIC CHARACTERISITICS OF COMMON STOCK• Each share of common stock represents an equity (or ownership) position in a company. It’s this equity position that explains why common stocks are often referred to as equity capital. Every share entitles the holder to an equal ownership position and participation, an equal vote, and an equal voice in management. • The more shares an investor owns, the bigger his or her ownership position.• Common stock remains outstanding indefinitely.• Most common stock is never traded.• Publicly Traded Issues are the shares that are readily available to the general public and that are bought and sold in the open marketISSUING NEW SHARES:• Most widely procedure is the public offering, where the corporation offers the investing public a certain number of shares of its stock at a certain price.• Rights offering – existing shareholders are given the first opportunity to buy the new issue.STOCK SPIN-OFFS:• A spin-off occurs when a company gets rid of one of its subsidiaries or divisions.• One of the most creative ways of bringing a new issue to the market.• Creates a new stand-alone company and then distributes stock in that company to its existing stockholders.• Companies execute stock-spinoffs if they believe the subsidiary is no longer a good fit or if they feel they’ve become too diversified and want to focus on their core products. STOCK SPLITS:• Stock Split can increase the number of shares outstanding.• In declaring a split, a firm merely announces that it will increase the number of shares outstanding by exchanging a specified number of new shares for each outstanding share of stock. For ex: in a 2-for-1 split, 2 new shares of stock are exchanged for old share. In a 3-for-2 split, 3 new shares are exchanged for every two old shares outstanding. • Company uses a stock split when it wants to enhance its stock’s trading appeal by lowering its market price.TREASRUY STOCK:• Firms repurchase their own stock when they view it as undervalued in the marketplace.• Treasury stocks are simply shares of stock that have been issued and subsequently repurchased by the issuing firm. Treasury stocks are kept by the corporation and can be used at a later date for any number of reasons.CLASSIFIED COMMON STOCK:• A company will issue different classes of common stock, each of which entitles holders to different privileges and benefits.• Used to denote either different voting rights or different dividend obligations.BUYING AND SELLING STOCKS• Become familiar with how stocks are quoted & with the transaction costs. • Keeping track of current prices is an essential element in the buy-and-sell decisions of investors.READING THE QUOTES:- To see how to read and interpret stock price quotations, consider the quotes that appear daily in the printed and online versions of the Wall Street Journal. TRANSACTION COSTS:- Investors can buy and sell common stock in round or odd lots.- The major cost is the brokerage fee paid, by both the buyer and the seller, at the time of transactions.COMMON STOCK VALUESPAR VALUE:- Refers to the stated, or face, value of a stock.BOOK VALUE:- Another accounting measure represents the amount of stockholder’s equity in the firm.- Commonly used in stock valuation.- CALCULATED: Assets – Liabilities & preferred stock- Can be converted to a per-share basis, book value per share, by dividing it by the number of common shares outstanding.- Most stocks have market prices that are well above their book values.MARKET VALUE:- One of the easiest stock values to determine.- Simply the prevailing market price of an issue.- Indicates how the market participants as a whole have assessed the worth of a share of a stock.- Market Capitalization: multiplying the market price of the stock by the number of shares outstanding.INVESTMENT VALUE:- Probably the most important measure for a stockholder- Indicates the worth investors place on the stock or what they think the stock should be traded for.THE DIVIDEND DECISION• By paying out dividends, companies share with their stockholders some of the profits they’ve earned. Board of Directors decides how much to pay in dividends.• Factors Board of Directors look for:- Firm’s earnings - Consider certain market effects and responses• With common stocks, the annual earnings are usually measured and reported in terms of earnings per share (EPS). - EPS = Net Profit After Taxes – Preferred Dividends / # of shares on C/S outstanding.• If a firm is investing the money wisely and at a high rate of return, fine; otherwise, pay a larger portion of earnings
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