Ch. 7 Stock (Equity) Characteristic and Valuation

Preferred Stock (hybrid security)

Has fixed dividend payments, dividends are not required to be paid and there is no specified maturity.

Preferred Stock Features

Par Value (nominal or face value), Cumulative Dividends (preferred divid previously not paid must be paid before common divid’s distributed), Maturity (no specific maturity date).

Common Stock

Owners of the corporation, investors in common stock have certain rights and privileges associated with property ownership.

Cumulative Dividends 

Protective feature on preferred stock that requires preferred dividends that were not paid tin previous years to be distributed before any common stock dividends can be paid 

Priority to Assets & Earnings (preferred stock)

Preferred dividends are paid after interest on debt is paid.

Preferred dividends must be paid before common stock dividends paid.

Control of the Firm (Voting Rights) (preferred stocks)

Preferred stock generally is nonvoting stock. Preferred stockholders neither elect the members of the board of directors nor vote on corporate issues.

(preferred stockholders given right to vote directors when preferred dividends go unpaid)

Convertibility (preferred stocks)

Preferred stock that can be converted into common stock at the option of the investor.

Call Provision

Gives the issuing corporation the right to call in the preferred stock for redemption. Involves call premiums like bonds.

Call Premium

The amount in excess of par value that a company must pay when it calls a security.

Sinking Fund

Calls for the repurchase and retirement of a given percentage of the preferred stock at particular times. Including call provision & sinking fund, essentially adds a maturity option to a preferred stock issue.

Participating

Preferred stockholders share (participates) with common stockholders in the distribution of the firms earnings.

Common Stock Features

Par Value (stockholders minimum financial obligation in the event corporation is liquidated), Dividends (no legal obligation to pay), maturity (no specific date)

Income Stocks

Stocks of firms that traditionally pay large, relatively constant dividends each year. Stocks that produce returns based primarily on dividends are called this because the dividend payments represent income to investors.

Growth Stocks

Stocks that generally pay little or no dividends so as to retain earnings to help fund growth opportunities. Returns on these stocks are generated primarily by capital gains, associated with the companies growth rates.

Priority to Assets & Earnings (common stocks)

Dividends can be paid only after interest on debt and preferred dividends are paid.

Control of the Firm (Voting Rights) (common stocks)

Common stockholders have the right to elect the firm’s directors and to vote on various proposals.

Proxy

A document giving one person the authority to act for another; typically it gives them the power to vote shares of common stock.

Preemptive Right (common stock)

Provision right to purchase additional shares of stock sold by he firm on a pro rata basis before the shares can be offered to new investors

Classified Stock

Type of common stock that is given a special designation such as Class A, Class B, etc., to meet special needs of the company 

Founder’s Shares

Type of common stock, owned by the firm’s founders, that has sole voting rights but generally pays out only restricted dividends (if any) for a specified number of years.

American Depository Receipts (ADRs)

Certificates representing ownership in stocks of foreign companies, are held by banks located in the countries where the stocks are traded. (equity instrument in international markets)

Foreign Equity (stock)

Ex. Yankee Stocks & Euro Stock. Primary difference between stocks of foreign companies and stocks of U.S. companies is that U.S. regulations provide greater protections of stockholders’ rights than other countries.

Yankee Stock

Stock issued by foreign companies traded in the U.S.

Euro Stock

Stock traded in countries other than the home country of the company, not including the U.S.

Market Price (Value), P₀

The actual price at which a stock currently sells in the market at the end of Year t.

Intrinsic (theoretical) Value, P^₀ 

The justified value of an asset perceived by a particular investor based on facts of the stock. Can be different from from assets current market price, its book value, or both. (the expected price of the the stock at end of Year t)

Growth Rate, g

The expected growth rate in dividends.

Required Rate of Return, r_s

The minimum rate investors demand to invest in the stock.

“P hat t”

The expected price of the stock at the end of the Year t.

Dividend Yield

Expected dividend yield in the coming year. Next expected dividend divided by the current price of a share of stock.

Capital Gains Yield

The expected capital gains yield in the coming year. Change in price (capital gain) during a given year divided by the price at the beginning of the year; (P hat₁ - P₀) / P₀

Expected Rate of Return, “r hat_s” (equal to expected dividend yield plus expected capital gains yield)

The actual price of the stock at the end of Year t. Rate of return stockholder expects to receive on common stock. The stock is considered “good” investment if equal or greater that required rate of return.

Constant Growth Model

Also called the Gordon Model, it is used to find the value of a stock that is expected to experience constant growth.

Nonconstant Growth

The part of the life cycle of a firm in which its growth is either much faster or much slower than that of the economy as a whole.

P/E Ratio (earnings multiplier)

Gives indication of a stocks “payback” period, the higher ratio the more investors are willing to pay for each dollar earned by the firm. The current market price of a stock divided by the earnings per share; P₀/ EPS_0.

Economic Value Added (EVA)

An analytical method that seeks to evaluate the earnings generated by a firm to determine whether they are sufficient to compensate the suppliers of funds - both the bondholder & stockholders.