FIN 320F Exam 3 Unit 10

The clientele effect

some investors prefer companies with steady dividend payments, while other investors prefer growth in the stock price rather than the income from dividends.

growth stock

Investment increases stock price as long as growth continues.

- Shareholder can sell shares and get capital gain.

income stock

Company growth slows and begins paying dividends.

Investment horizon/holding period

The time period that the investor plans to hold the stock.

- when one person sells to another they transfer claim of future pmts (value does not change)

- horizon issues occur when indefinite life of corporation collides with finite life of individual investor

Dividends

regular payments to the shareholders that generally represent a distribution of profit.

-payments are not guaranteed: the Board of Directors will issue a dividend only if they believe the company has enough cash or profits.

- typically a perpetuity

Dividend Discount Model (perpetuity)

Stocks have: no defined maturity and dividends that can grow with company profits over time.

formula: P0=DIV1/ R - g (DIV1 = cash flows provided by dividends; g=growth rate; r= stock's opp cost)

when diven Div at yr 0 --> P0=DIV0*(1+g)/r-g

formula solving for R: R = DIV1/P0 + g

only works if r is bigger than g; works with - or 0 g

past tense = Div0

future tense= div1

no dividend payout

1. some don't pay div bc they dont have profit (young comps)

2. some don't bc comp can earn and offer higher rate of return on retained earning (fast growing innovative comps)

level perpetuity

same dividend each period

preferred stock (div does not grow)

constant growth perpetuity

dividends grow each period

common stock (benefit from company doing well)

dividend yield

the proportion of return from dividend payments

Div1/P0

- rarely more than 5%

capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows

- comes from: Reinvested profits/retained earnings or Rate earned on retained earning

- usually larger than div yield

P1-P0/P0

Capital gain

An increase in the value of an asset over its purchase price.

Stock buybacks

A company can use buy back its shares from the stockholders.

- This gives the shareholders a (hopefully) capital gain and cash

- It also reduces the number of shares outstanding.

growth formula

g=retention ratio x ROE

Return on Equity (ROE)

The rate of return that shareholders get on their investment in the corporation.

The Retention Ratio

the proportion of earnings (Net Income) that is retained and reinvested in the company.

The price/earnings ratio (P/E)

the ratio of the stock price divided by the company's Earnings per Share (EPS).

Earnings per Share (EPS)

The net income of the company divided by the number of shares.

- states the income of the company on a per-share basis, which is useful when we're evaluating the price of a single share of stock.

P0=EPS/R

additivity principle

new stock price= existing stock price + NPV per share

+ NPV projects increase stock price

- NPV projects reduce stock price