Fin Study Guide Final Exam Exam Date Room 1 Common Stocks Chapter 11 Stock Ownership Residual owners owners stockholders of a rm who are entitled to dividend income and a prorated share of the rm s earnings only after all other obligations have been met No guarantee that they will receive any return on the investment The allure of common stocks is that they will increase in value over time and generate signi cant capital gains and dividends Bad days are the exception rather than the rule Big returns or losses come from capital gain Stocks generally earn positive total returns over long time periods From 1950 2000 the average total return on the S P 500 was 13 7 per year At that rate investors can double their money every 5 or 6 years How long it will take for your money to double 72 interest rate Investing in stocks is clearly not without risk Advantages Provide attractive highly competitive returns in the long haul Typically outperform bonds and usually by a wide margin Provide investor protection from in ation over time their returns exceed the in ate rate Easy to buy and sell Transaction costs are modest Disadvantages market risk and event risk Subject to various types of risk including business and nancial risk purchasing power risk Earnings and general performance are subject to wide swings so it is dif cult to value Publicly traded issues shares that are readily available to the general public and that are common stocks a consistently select top performers The sacri ce in current income bought and sold in the open market In 2008 the value of stocks was at 12 trillion Classi ed common stock different classes of common stock that are issued and each of which entitles holder to different privileges and bene ts Customarily used to denote either different voting rights or different dividend obligations Issuing New Shares of Stock Two ways to issue new shares 1 Rights offering existing shareholders are given the rst opportunity to buy the new issue Purchase in proportion to his or her current ownership position Example if a person owns 1 of a rm s stock the rights offering will give that stockholder the opportunity to purchase 1 of the new issue Can also sell the rights to someone who wants them 2 Public offering the corporation offers the investing public a certain number of shares of its stock at a certain price 2 Stock Splits Stock splits a maneuver in which a company increases the number of shares outstanding by exchanging a speci ed number of new shares of stock for each outstanding share Uses stock splits when it wants to enhance its stock s trading appeal by lowering its market price Stock split Original price per share ratio of new shares to old Round Odd Lots Round lot 100 shares of stock or multiples thereof Odd lot a transaction involving fewer than 100 shares Trading 250 shares of stock would involve a combination of two round lots and an odd lot Common Stock Values Par Value the stated face value of a stock Relatively useless except for accounting purposes Because the term has little or no signi cance for investors many stocks today are issued as no par or low par stocks They only have a par value of a penny or two Book Value the amount of stockholders equity in the rm Book Value assets liabilities preferred stock Book value per share book value number of common shares outstanding Market Value the prevailing market price of an issue Indicates how the market participants as a whole have assessed the worth of a share of stock Market capitalization the market value of the rm Market capitalization market price of the stock X number of shares outstanding Earnings Per Share EPS Earnings per share EPS terms in which annual earnings of a rm that are usually measured and reported EPS net pro t after taxes preferred dividends number of shares of common stock outstanding Types of Dividends Cash dividends cash ow from stocks More rms pay cash dividends than any other type of dividend They tend to increase over time as companies earnings grow The average annual increase in dividends is around 3 to 5 A steadily increasing stream of dividends tends to shore up stock returns in soft markets Dividend yield indicates the rate of current income earned on the investment dollar Convenient way of assessing the amount of dividends received Dividend Yield Annual dividends received per share current market price of the stock Dividend payout ratio describes the portion of earnings per share EPS that is paid out as dividends Dividend payout ratio dividends per share earnings per share 3 Stockholders don t like to see payout ratios higher than 60 to 70 because high payout ratios are dif cult to maintain and may lead the company into trouble The appeal of cash dividends took a giant leap forward in 2003 when the federal tax code changed to reduce the tax on dividends Both dividends and capital gains are taxed at the same low preferential rate of 15 or less already owned stock dividend Stock dividend dividend paid by issuing additional shares of stock Stock dividends really have no value because they represent the receipt of something The market responds to such dividends by adjusting share prices according to the terms of The market value of you shareholdings after a stock dividend is likely to be the same as it was before the stock dividend Not taxed until you actually sell the stocks Dividend Reinvestment Plans DRP Dividend reinvestment plan DRP a corporate sponsored program in which shareholders can have their cash dividends automatically reinvested into additional shares of the company s common stock If the company s good enough to invest in then it s good enough to reinvest in Convenient and inexpensive way to accumulate capital Partial participation participants specify a portion of their shares for dividend reinvestment and receive cash dividend on the rest Most plans will credit fractional shares to the investor s account and many will even allow investors to buy additional shares of the company s stock Shareholders can join dividend reinvestment plans by simply sending a completed authorization form to the company Once you re in the number of shares you hold will begin to accumulate with each dividend date Must still pay taxed on these dividends as though they were cash Types of Stocks Treasury Stocks shares of stock that have been sold and subsequently repurchased by the If the company feels that their stock is undervalued they can increase the price by buying This contracts the
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