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FSU FIN 3244 - Chapter 11 – Common Stocks

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Chapter 11 – Common StocksStock Price BehaviorThe economy and average stock returns typically move togetherCapital gains create higher returns than dividendsStock investing is risky: a firm must meet all other financial obligations before paying stockholdersThere is no guarantee stocks receive any return on their investmentAdvantages of Stock OwnershipStocks are so appealing because they have a greater chance for higher returns than long-term bonds and U.S. treasuries.Usually provide attractive, highly competitive returns over a long period of time.Stocks provide protection from inflation because over time their returns exceed the inflation rateHighly liquid: easy to buy and sell with low transaction costsUnit cost per share is cheaper than bondsTax costs are relatively smallEasy accessible market info keeps stocks selling at fair pricesDisadvantages of Stock OwnershipProne to business, financial, purchasing power, market, and event risksGovernment control, foreign competition, and state of the economy can affect sales/profits, which will affect price behavior of stocks and dividend paymentsNot only is the future outcome of a company and it’s stock uncertain, but the evaluation of stock performance is also extremely complex and far from perfectStock ownership sacrifices current incomeStocks typically have lower returns and greater uncertainty compared to debt investmentsWide swings in earnings and stock market performances are commonYield = Annual current income/current market priceCommon StockEquity Capital: Evidence of ownership in a firmEach share entitles an owner to an equal ownership positionEqual vote and equal voice in managementThe common stockholders own the company, the more shares you own, the bigger your ownership positionAll corporations “issue” common stock, but most are never traded because the firms are either too small or are family (privately) controlledPublically trades issues: shares that are readily available to the general publicBought and sold in an open marketIssuing New SharesIPO: determine number of firm’s shares at a specific price that are available to the publicProceeds from “new” shares go to the firmExisting shareholders receive proceeds from selling shares to new investorsRights offering: existing stockholders are given the first opportunity to buy the new issued shares in proportion to their current ownershipResults from both IPO and Rights Offering:Firms have more equity in it’s capital structureNumber of shares outstanding increasesStock Spin-offs: occurs when a company gets rid of one of its subsidiaries or divisionsCreates a stand-alone company and distributes stock in that company to existing shareholdersNormally execute stock spin-offs if they believe subsidiary is no longer a good fit or if the company wants to focus on their core productsStock Splits: a firm announces that it will increase the number of shares outstanding by exchanging a specified number of new shares for each outstanding share of stockCompanies use stock splits when they want to enhance their stock’s trading appeal by lowering its market priceTreasury stock: Companies buy back their own stock to reduce the number of outstanding sharesFirms do this when they feel their stock is undervalued in the marketplaceBuy back at market priceTreasury stock usually used for mergers, to meet employee stock option plans, or as a means for paying dividendsMakes stock appealing to outside investorsCommon/Preferred StockClassified common stock: Issues of different classes of common stock, each of which entitles holders to different privileges and benefitsVoting rights and dividend amounts usually differ in classesOften lets a small group control major decisions of publicly-traded firmsPreferred stock: Stock with stated dividend rate with preference over common stock dividends of the same firmCommon Stock ValuesPar value: Stated or face value of a stock.Except for accounting purposes, it is relatively uselessBook value: represents the amount of stockholders’ equity in the firmIndicates the amount of stockholder funds used to finance the firmMarket value: simply the prevailing market price of an issueIndicates how the market participants as a whole have assessed the worth of a share of stockMV of firm: (market price of stock) x (# of outstanding shares)Investment value: indicates the worth investors place on the stock – in effect, what they think the stock should be trading forBased on predictions of how much money they will make from capital gains and dividendsDividendsA firm’s board of directors makes the dividend decisionEvaluate firms financial condition to determine if they should pay a dividend or notPay dividend? Repurchase shares? Do nothing?Though firms don’t need a profit to pay a dividend, they still play a vital roll in the dividend decisionEPS= net profit after taxes – preferred dividends/number of common stock shares outstandingBoard of directors also looks at the firm’s growth prospects, cash position, and contractual obligationsTend to increase as company’s earnings grow and firm matures over timeDividend DatesDeclaration date: date dividend is announcedDate of record: date on which the investor must be a registered shareholder of the firm to be entitled the dividend – ends at the close of the business for that dayThese stockholders are referred to as holders of recordPayment date: generally follows the record date by a week or so and is the actual date the dividend checks are mailed to holders of recordEx-dividend date: dictates whether you were an official shareholder and therefore eligible to receive the declared dividendAllows time for bookkeepingStock prices fall by dividend amountMore on DividendsCash DividendsMost common type and should increase over timeAverage annual growth is 3-5%Dividend yield = annual dividends received per share/current market price of the stockDividend Payout Ratio: dividends per share/earnings per shareTax break on dividends has been in effect since 2003Stock DividendsSimply means that the dividend is paid in additional shares of stockDo not hold any valueTaxes deferred until shares are soldDividend Reinvestment Plans (DRIP)Shareholders can have their cash dividends automatically reinvested into additional shares of the firms common stockNo brokerage commissions and most firms allow partial participationPay taxes as if they were cash dividends in the year the dividend was receivedStock TypesBlue-Chip Stocks:


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