Outline Chapter 11 Common Stock Stock o General behavior Shareholders are all part owners of the firm have claim on part of profit o residual claim is subordinate firm must meet all other financial obligations before paying them no guarantee Reflected in S P 500 DJIA s tracking of capital gains dividends Risky always changing Stock market and economy typically move together o Based on the public s perception on how firms will do o Different views on different issues gas prices going down ex Usually stocks earn positive returns over long periods of time o Partially due to inflation o Difference between individual and group movement Group movement is based on averages implying that half firms are moving above and half are moving below 99 stocks can be going up but 1 can be going down Group movement is a benchmark not an indication of individual movement Returns o Capital gains Difference between selling price and purchase price Only measurable once you sell stock until then they are just paper gains Where the majority of returns come from Not taxed until sold Can be positive or negative o Dividends current income Smaller than capital gains but more stable and reliable Periodic payments of partial return on profits Only given when company can afford it Taxed Cannot be negative Can boost capital gains and offset losses Cushion for when market stumbles special dividends 1 time deal not to happen again Pros o Greater chance of higher returns than more other asset classes 2x bonds o Hedge against inflation Invested in firms that can rise prices to compensate for changes in inflation price of stock stays the same Over time returns exceed inflation rate o Highly liquid 1 You can always find someone to buy from or sell to for a fair price Price you receive is the price people are willing to buy and sell at therefor it is fair market price o Transaction costs are relatively small Commission is small Most people can afford to invest no min or price Price market info is widely disseminated in the news and financial o Easy to get info media Cons o Volatile subject to many risks Internal comes from within firm ie management tech updates External firms have no control ie oil prices rise terrorist attack o systematic risk impacts all firms just at different degrees o Hard to predict the future Applicable to firm market AND economy Many reasons for people selling that are unknown Hard to analyze the market everyone has different views o Sacrifice current income won t get most of it back until receiving capital gains Dividends are smaller returns than that on bonds o Earnings and general performance are subject to wide swings o Selection process is hard o Company income is subject to many factors ie government control and regulations foreign competition state of economy Ways firms alter their market value MV shares x price o Stock splits Why o Used to enhance stock s trading appeal by lowering the market price as of shares increases the price decreases o Usually cause good returns in the following year o 2 theories Trading range theory people get used to trading stock within trading range get too comfortable with the same fluctuations prices tend to increase over time eventually making the shares too expensive for most investors also people tend to think that after an extended period of time their stock is not going to get any higher want to sell it basically maintains the trading range investors are comfortable with while keeping shares affordable Signaling theory company is signaling to market that they think their stock is underpriced and want market to take another look at it 2 How o Spin offs Why o 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 stock ie 2 for 1 3 for 2 o New number of shares is always greater than old number o Market value doesn t change it is just divided differently o The company may believe one of its subsidiaries or divisions is no o Company might also feel they ve become too diversified and want longer a good fit to focus on core products o Company might also think the subsidiary division could reach its full potential profit on its own o Company gets rid of a subsidiary or division by making it a stand alone company then distributes stock for this company to its existing shareholders so that their market value stays the same o Firm gets smaller but the number of stocks outstanding stays the How same o Stock repurchases buybacks Why o Firms view their stock as undervalued in the market place therefore want to reduce the number of outstanding shares in circulation and invest in them in hopes that their prices rise o Also firms may want to use this as a means of returning profit to their shareholders How treasury stock o Firms purchase their stock in the open market it becomes o Less dividends to pay less stocks outstanding o Can sometimes cause prices to rise just from the firm announcing they plan on repurchasing because people will rush to purchase them resulting in firms possibly not having to buyback any at all o Market value stays the same Treasury stock o Shares that have been issued and repurchased by their issuing firm part of corporate treasury o Can be used for things such as Mergers acquisitions To meet employee stock option plans Paying stock dividends o Seasoned offerings Why 3 o Firms want to raise equity capital by selling new shares of stock o Firms that have already gone public announce that they are selling How new shares of stock Rights offerings o Existing stockholders are given the first opportunity to buy new shares of stock being issued in proportion to their current ownership o Allows stockholders to maintain same of ownership in the firm as it did before new shares were sold not lose money MV stays the same Can purchase the new shares for cheaper the price is set lower than the original to encourage them to buy Can sell these rights to people interested in buying new shares Publicly vs privately traded o Most firms are not publically traded for various reasons Too small Family other private control Exposed to general public SEC regulations Common Shares Outstanding ownership rights o All owners have same rights Equal vote Equal voice in management Classes of Common Stock o Different classes give different privileges to different holders purchased for different prices Voting rights o Ex no voting can vote certain of control Dividend amounts o Ex
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