Equity Securities Review

Common stock

An equity security; buyers become part owners ("shareholders") of the corporation.

Two ways to profit from stock

Dividends (share of profits) and capital gains (selling for more than paid).

Capital loss

Selling shares for less than you paid.

Upside potential of stock

Unlimited (no cap on how high the price can go).

Maximum loss on common stock

The full amount invested (if the price goes to $0).

Limited liability

Shareholders are NOT responsible for the corporation's unpaid debts to creditors.

Registered form

Certificate issued in the shareholder's own name, recorded on company books.

Street name

Stock registered in the broker-dealer's name; customer is the beneficial owner.

Corporate books shareholders can inspect

Certain ones only, generally the balance sheet and income statement.

When do shareholders receive dividends?

Only when declared by the Board of Directors.

Order of asset distribution in liquidation

1) Taxes 2) Secured debt 3) Unsecured debt 4) Preferred stock 5) Common stock.

Greatest risk in liquidation

Common stockholders (paid last).

Two ways to vote

In person at the annual meeting, or by proxy (absentee ballot).

Statutory / Regular voting

1 vote per share per director seat; max 1 vote per share to any one candidate. Benefits large stockholders.

Cumulative / Block voting

Votes = shares × number of directors; can put all votes on one candidate. Benefits minority stockholders.

Supervoting shares

A class with more than 1 vote per share (e.g., Class B = 10 votes); lets insiders keep control.

Are common shareholders entitled to dividends?

No; dividends are always a "want to," never required.

Do common shareholders vote to dissolve the company?

No.

Do common shareholders vote for officers / management?

No; the Board of Directors picks officers. Shareholders elect the Board.

Best hedge against inflation

Common stock (historically highest return in inflation).

Greatest long-term capital appreciation

Common stock (more than preferred stock or bonds).

What hurts common stock?

Higher taxes, rising interest rates, falling GDP, high unemployment.

What helps common stock?

Lower taxes, lower interest rates, rising GDP, low unemployment.

Round lot

100 shares.

Is common stock ever callable?

Never.

Authorized stock

Maximum shares a corporation may issue, set by its corporate charter.

Issued stock

Shares taken from authorized stock and sold to the public in a primary distribution.

Unissued stock

Authorized shares not sold to the public.

Treasury stock

Previously outstanding shares the company repurchased.

Treasury stock 4 facts

Does NOT vote, does NOT get dividends, NOT used in EPS, shown as a deduction from issued stock.

4 reasons a company buys back its stock

1) Increase EPS 2) Finance future acquisitions 3) Provide stock for employee stock option plans 4) Fight a takeover.

Outstanding shares

Issued shares held by stockholders; the ONLY shares that vote, get dividends, and count in EPS.

Outstanding shares formula

Issued − Treasury = Outstanding.

Long position

Investor buys/owns the security and expects price to rise (Bullish).

Short position

Investor borrows stock and sells it, hoping to buy back lower (Bearish).

Par value (stock)

Fixed value printed on the certificate; little relevance to investors.

Market value

Price the stock sells for in the open market, set by supply and demand.

Regular way settlement (common stock)

T+1 (1 business day after trade date).

Regulation T payment

Payment due by T+3; Fed rule covering extension of credit to customers.

Blue chip stocks

Nationally known, quality companies that pay consistent moderate dividends in good and bad times.

Growth stocks

Above-average revenue/earnings growth; retain earnings, pay little or no dividends, high P/E ratio.

Cyclical stocks

Rise and fall with the economy (e.g., autos, steel, appliances, housing).

Countercyclical stocks

Move opposite the economy (e.g., gold mining, budget retailers, temp agencies).

Defensive (non-cyclical) stocks

Resist business cycles; stable, consistent earnings (e.g., tobacco, utilities, food, pharmaceuticals).

Utility stocks sensitivity to interest rates

Heavy debt means rising rates raise their interest costs.

American Depositary Receipts (ADRs)

Receipts traded in the U.S. for foreign stock held by a U.S. bank abroad.

Stock split purpose

Increase number of shares and increase marketability by lowering the share price.

Reverse split

Decreases shares and increases price per share; can signal trouble.

Warrant

Long-term option to buy stock from the issuer at a set price; transferable.

Warrants are most often issued with

Debentures (unsecured bonds) so the company can pay a lower interest rate.

Rights (subscription / preemptive)

Short-term privilege letting existing shareholders buy new shares below the public offering price.

Maximum life of rights

90 days.

Rights needed for 1 new share formula

Outstanding shares ÷ New shares.

Why is preferred stock called "preferred"?

Priority over common for dividends and assets in liquidation.

Is preferred stock fixed income?

Yes; fixed dividend makes it interest-rate sensitive.

Cumulative preferred

Unpaid past dividends plus current must be paid before common gets anything.

Convertible preferred

Can be converted into common at holder's option.

Callable preferred

Issuer can redeem at a premium over par after a set date (favors issuer).

Tax on qualified dividends

Generally 15% federal tax rate.

Order of dividend dates

D-E-R-P: Declaration, Ex-date, Record, Payable.

Ex-dividend date

Stock trades without the dividend; must buy at least one business day before to be entitled.

Current (dividend) yield formula

Annual dividend ÷ Market price.

REIT payout rule to avoid trust-level tax

Pay out at least 90% of income.

REIT asset rule

At least 75% of assets in real estate.

REIT dividends taxed at

Ordinary income rates.

Do REIT losses or depreciation pass through?

No (unlike DPPs).

General partner in a DPP

Sponsor/manager who runs the business and has unlimited liability.

Limited partner in a DPP

Liability limited to their at-risk investment.

Adjusted basis in a DPP formula

Cost + contributions + income − distributions − losses.

Tax form for limited partners in a DPP

Form K-1.

Do DPP losses pass through?

Yes, but limited partners can never write off more than their adjusted basis.