FIN3244 Chapter 11 Common Stock 1 What common stocks have to offer a Enables investors to participate in the profits of a firm b Except they are Residual owners i Meaning their claims on the company come after lenders The company has to meet their financial obligations first There is no guaranteed return on common stock c When the market is strong the stock will generally appreciate 2 Advantages of common stock a Returns are nearly double that of High grade corporate bonds b Provide protection from inflation as returns exceed inflation c Easy to buy and sell d e Stocks can be cheap no minimum investment or of stocks need to be purchased Information on stocks is widely known through news newspapers 3 Disadvantages of Common Stock a Risk Business and Financial purchasing power risk market risk event risk b Subject to wide swings so it is difficult to value stocks and pick winners c The sacrifice of current income earn less dividend yields than bonds 4 Basic characteristics of Common Stock a Each share represents an equity ot ownership in a company equity securities or equity capital b Publicly Traded Issue shares that are readily available to the general public bought and sold on the open market c Public Offering offers a specific number of shares at a specific price d Rights Offering gives existing shareholders the first opportunity to buy the new issue in proportion to their share now So if they own 1 they could buy 1 of the new offering e Stock Spin Offs are when a company gets rid of one of its subsidiaries or divisions by separating it and issuing new stocks of the new company to existing shareholders f Stock Splits a firm announces it will merely increase the number of stocks by 2 for 1 200 shares becomes 400 i Companies do this to increase its market appeal by lowering its market price g Treasury Stock sometimes firms find it desireable to lower the of outstanding shares by buying existing shares back Buybacks i Usually done when they believe it is undervalued to raise the price h Classified Common Stock usually denotes different voting rights or different dividend obligations 5 Buying and Selling a Round Lot is 100 shares of stock or multiple therof b Odd Lot is a transaction involving less than 100 shares c Transaction Costs include 6 Valuation i Transfer fees and taxes paid by the seller ii Brokerage fee paid by both the buyer and seller iii Higher fees go along with odd lots because you usually have to go through an odd lot dealer and pay an odd lot differential tacked onto the stock price 10 25 cents per share a Par Value the stated or face value of a stock Other than accounting purposes it is fairly useless Now adays stocks are either no par or low par a penny b Book Value another accounting measure represents the amount of stockholders equity in the firm The amount of stockholder funds used to finance the firm c Market Value is the prevailing market price of an issue i Makret price x shares outstanding market value of firm or market capitalization d Investment Value is probably the most important measure for a stockholder It indicates the worth investors place on the stock What they think it SHOULD BE trading for Represents the max an investor should be willing to pay 7 Dividends a Taxed the same as capital gains b Cash flow is more certain c Provide a cushion if the market falls d Less risky 8 Dividend decision a A company does not need to show a profit to pay dividends but it is a link b Earnings per share EPS translates aggregate corporate profits into profits on a per share basis c Important Dates i Net profit after taxes preferred dividends number of common stocks outstanding i Date of record is the date on which the investor must be a registered shareholder to receive the dividend holders of record ii Payment Date set by the board of directors follows the record date It is the actual date on which the company will mail dividend checks to holders of record iii The ex dividend date if you sell the stock on or after the ex dividend date you will receive the dividend Because you were the holder of the stock when the date of record was declared If you sold it before ex dividend you will not receive the dividend i Cash dividends most common tend to increase over time as companies earnings grow a steadily increasing stream of dividends tends to shore up stock returns in soft markets 1 Dividend yield annual dividends received per share current market price of the stock 2 Dividend payout ratio dividends per share earnings per share ii Stock dividends means the dividend is paid in additional shares of stock If there is a 10 stock dividend ashreholder will receive 1 new stock for every 10 they own 1 Not much value but they aren t taxed until you sell them iii Dividend Reinvestment Plans d Types of dividends 1 Shareholders can have their cash dividends automatically reinvested into additional shares of stock Can have partial participation Not the same as stock dividends these are taxed 9 Types of common stock a Blue chip stocks issued by large and credible firms with long and stable record of earnings Cream of the crop set the standard for their industries Good for long term investment steady return and dividends Income stocks regularly pay higher than average dividends Usually not exposed to a lot of business and market risk but are subject to interest rate risk b c Growth stocks are consistently high rates of growth in operations and earnings Usually no dividends Good in good markets bad in bear markets d Tech Stocks are in the technology sector of the market Primarily on Nasdaq e Speculative Stocks lack sustained records of success but offer the potential for price appreciation Wide swings and little dividends Highly risky f Cyclical stocks earnings are closely related to general level of business activity Construction companies etc g Defensive Stocks remain stable or even increase when general economic activity is tapering off Less affected by downswings Public utilities Walmart h Mid Cap Stocks are companies that have a market cap between 2 billion to 10 billion Fairly safe and provide opportunities like small cap i Baby blues have the characteristics of blue chips except for size i Small Cap have revenues less than 250 million but because of their size they can experience great growth here today gone tomorrow IPO s 10 Investment Strategies a Storage of value prefer safer blue chip stocks b Accumulation of Capital for long term investment goals build up wealth
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