CSC - Chapter 8 (Equity Securities: Common & Preferred Shares)

Who is given first priority in the event of a company bankruptcy?

Bondholders

What do common shareholders get in the case of bankruptcy?

- the remaining assets after paying bondholders, debenture holders, preferred shared holders etc.

What are dividends?

Company's profit that it decides to share with its shareholders

Are dividends discretionary or compulsory in the case of common shares?

unlike with bonds, dividends are not compulsory to common shareholders

Who decides whether a company will pay dividends to its shareholders?

The company's board of directors decide whether to pay dividends. If they do decide to, common shareholders have a right to these dividends.

What are the two ways to buy common shares?

1. in your own name

- e.g. you can buy apple stock in your own name, so apple has a record of your name as a shareholder

2. Street certificate

- you buy apple stock in a dealer's name. e.g. you can buy apple stock through Scotiabank. Whatever dividends Scotia receives by apple are then distributed to its shareholders

What is a trading unit?

The number of shares of a particular security that is used as the acceptable quantity for trading on the exchanges

Trading units are often in the form of round lots or odd lots. What is a standard lot? What is an odd lot?

standard lots are usually 100 shares of stock

- 90% of trading happens in standard units

- you pay less when you buy shares in standard units

odd lots are a number less than 100

- more commissions than standard lots

What are the rights and advantages of being a common shareholder?

- potential for capital appreciation

- the right to dividends

- favorable tax treatment for dividends and capital gains

- voting privileges

- limited liability (your loss cannot exceed your investment)

- marketability (you can sell the shares in secondary market)

- right to receive quarterly/annual reports

- right to question management at shareholders meeting

- right to question management at shareholder meetings

What are risks of common shareholders?

- issuer has no obligation to pay dividends

- little influence over day to day operation

- volatile prices and losing money

- last claim to assets

What is capital appreciation?

- share prices appreciate because a company increases in assets, profits, future potential, and other factors

What is the concept of retained earnings?

when a company earns profit, it can reinvest into its own business

- the reinvestment is called retained earnings

- helps companies grow

What is the record date?

- the date on which the company closes its books for dividend payment

- if your name is on the company's record book as a shareholder by the record date, you would be considered eligible to receive the dividend

- record date is usually 2 to 4 weeks before actual payment

What is cum dividend?

If you buy shares cum dividend, it means you will receive the dividend

- up to two business days before the record date

What is ex dividend?

If you buy shares ex dividend, it means you will not receive the dividend

- starts one business day before the record date

If you buy a share on Aug 10th, when will it settle?

Aug 12th (two business days after the purchase date)

is Aug 10th cum dividend or ex dividend if the record date is Aug 12th?

Cum dividend

is Aug 11th cum dividend or ex dividend if the record date is Aug 12th?

Ex-dividend because the settlement date for Aug 11th purchase isn't until Aug 13th

If the record date is Wed Oct 17, identify the cum dividend cut off and the ex dividend cut off

cum dividend cutoff: Mon Oct 15

ex-dividend cutoff:

Tues Oct 16

If record date is Oct 17, which of the following buyers will get dividend?

- Buyer 1: Fri, Oct 12th

- Buyer 2: Mon, Oct 15th

- Buyer 3: Tue, Oct 16th

- Buyer 4: Wed, Oct 17th

- Buyer 5: Thurs, Oct 18th

- Buyer 6: Fri, Oct 19th

- Buyer 1: Fri, Oct 12th CUM

- Buyer 2: Mon, Oct 15th CUM

- Buyer 3: Tue, Oct 16th EX

- Buyer 4: Wed, Oct 17th EX

- Buyer 5: Thurs, Oct 18th EX

- Buyer 6: Fri, Oct 19th EX

What are regular dividends?

A payment of the dividend is maintained, barring changes to the firm's finances/operations

What are extra dividends?

- a bonus paid in addition to the regular dividend

- doesn't imply this extra payment will be made regularly

What is a stock dividend?

- in the form of additional stock rather than cash

- typically paid by rapidly growing companies

- treated as regular dividends for tax purposes

What is DRIP (Dividend Reinvestment Plan)?

- dividends are used to purchase additional stock in the company and not paid in cash

- taxable the same as cash dividend

- shareholders benefit by saving on commission to purchase the underlying stock (because they're bought in bulk)

- benefit from dollar cost averaging

What is the difference between a stock dividend and a DRIP (dividend reinvestment plan)?

- stock dividends result in the creation of new shares (company is creating more shares to give to you)

- DRIP results in the company buys shares from the open market

What are restricted shares?

Shares which have the right to participate to an unlimited degree in the earnings of a company and in its assets on liquidation, but don't have full voting rights

What are the three types of restrictive shares?

- non-voting: shares that are not voting, except perhaps in certain limited circumstances

- subordinate voting: shares which carry a right to vote, where there's another class of shares outstanding that carry a greater voting right on a per share basis

- restricted voting: shares which carry a right to vote, subject to a limit or restriction on the number or percentage of shares that may be voted by a person, company or group

What are the stock exchange regulations to protect investors that purchase restricted shares?

1. The restricted shares must be identified by appropriate share terms (i.e. you can't mislead an investor into thinking they bought common shares when they're actually restricted)

2. Restricted shareholders have the right to receive all documents/statements that normal shareholders receive

3. The restricted shares are identified in financial press by a certain code that's different from that of common shares

4. Dealers and advisors must identify the restricted shares to the shareholders (cannot mislead the investor)

5. Restricted shareholders must receive notice of shareholders meetings and have the permission to speak and question (but may not have permission to vote)

6. Minority approval is required for creating restricted shares

What is a stock split?

To reduce the price of a share to a popular trading range

What does it mean if an investor owns 100 shares with a current share price of $40 and the company announces a 2:1 split?

- means that each share is split into 2

- 100 shares become 200

- Each share is now $20

Why would a company want to split its stock?

- To make the stock more affordable to investors

- If a company is doing really well, investors may not purchase shares if the stock price is unaffordable

What is a consolidation / reverse stock split?

- when a company consolidates the number of existing shares of stock into fewer (higher-priced) shares

Why would a company consolidate their shares (do a reverse stock split)?

to raise the market price of the stock and improve the company's ability to refinance

if the price of a company's stock drops too much, it may get delisted from its current Stock Exchange. Consolidating helps prevent this

What does it mean to have a 1:10 reverse split when the price is 40 cents (if the investor owns 1,000 shares)?

- 1 new share for every 10 old shares

- investor now owns 100 shares

- each share is now $4

Interpret the following Stock Quote:

High: 12.55

Low: 9.25

Stock: BEC

Div: 0.50

High: 10.65

Low: 10.25

Close: 10.35

Change: +0.50

Volume: 6,000

High: 52 week high of $12.55 per share

Low: 52 week low of $9.25 per share

BEC: name of company

Div: Paid $0.50 dividends in the last 52 weeks

High: Day high of $10.65 per share

Low: Day low of $10.25 per share

Close: Last trade was made at $10.35

Change: The closing price was $0.50 higher than the previous trading day's closing trade price

Volume: 6,000 common shares traded that day

Why are they called Preferred Shares?

- Dividends must be paid before common share dividends

- In case of business failure, preferred shares rank ahead of common shareholders

Why would a company issue preferred shares instead of debt (bonds)?

- preferred shares don't have "contractual obligations" to pay dividends

- no maturity date (when bonds mature, the company has to pay back the principal amount)

- Greater flexibility for company (doesn't increase debt ratio)

Why would a company issue preferred shares instead of common shares?

- Preferred shareholders are only entitled to a "fixed" return (no dilution of earnings)

- Preferred shareholders don't have ownership of any profits/assets exceeding their par value

Why would an investor choose to own preferred shares?

- the tax flows are tax advantageous compared to bonds (dividend income rather than interest income AND you receive dividend tax credit)

- preference in dividends compared to common shares

What are the dangers of owning preferred shares as an investor?

1. purchasing power risk (if inflation goes up, your dividend may not have as much value)

2. If interest rates go up, the value of preferred shares goes down (and vice versa)

3. If the company is not profitable, they aren't OBLIGATED to pay dividends (like they would be to bondholders)

4. The company could fail and preferred shareholders could lose out on any future dividends

In what situation would a company issue preferred shares?

- If their existing assets are heavily mortgaged (they can't take on additional debt)

- market conditions may not be suitable for debt or equity issues so preferred shares make the most sense

- the company's debt to equity ratio is very high

- reluctance to assume legal obligation to pay interest and principal

- Paying preferred shares may be cheaper to issue than bonds

What are the features of preferred shares?

- Par value

- Dividends are stated as a percentage of par value or they're stated in dollar terms

- No maturity date

- No voting rights (unless dividends have been skipped for several periods)

What are the two types of preferred shares?

1. Cumulative

- if a dividend is not paid in a particular year, you have the right to receive the missed dividends in the future (called arrears)

- preferred dividend arrears must be paid before common dividends are paid

2. Non cumulative

- if a dividend is skipped, the preferred shareholder is not entitled to it in the future

3. Convertible

- The right to convert to common shares at a specified time and price

- Sometimes a company will force this conversion

4. Retractable

- Creates a "maturity" date

- Investors can force company to buy back par value at a specified time and price

5. Floating-rate or Variable rate

- interest rates keep fluctuating and dividend rates also fluctuate based on interest rates

What are the advantages of convertible preferred shares?

- potential capital gain on the common shares

- security of preferred shares

- higher yield than common shares

- no commission on conversion

What is the disadvantage of convertible preferred shares?

- lower yield than straight preferred shares

Are convertible preferred shares usually issued at a premium?

- Yes.

- if a common stock is trading at $100, a preferred stock that can be converted into common stock will be traded at above $100

What are the advantages of retractable preferred shares?

- there's a retraction date

- they are desirable as market rates rise (you can reinvest the proceeds at a higher rate)

- price is less volatile as the retraction date approaches

- There's a capital gain if you purchased the retractable share at a lower price and then sell at a higher price at retraction

What are the advantages of floating rate preferred shares?

- Protection against interest rate increases

- Price is less volatile

What is the disadvantage of floating rate preferred shares?

dividends will decrease if interest rate falls

What are foreign pay preferred shares? What is the advantage and disadvantage?

- it pays dividends in some other currency

- advantage: foreign exchange gains if Canadian dollar falls (if you're receiving dividends in USD$)

- disadvantage: foreign exchange risk if Canadian dollar rises (if you're receiving dividends in USD$)

What are participating preferred shares?

- they have the right to additional dividends on top of the fixed dividend

What are deferred preferred shares?

- they don't pay any dividends, but the gain you receive is the difference between the price you bought the shares at and the price you sell at

- dividends compound without having to pay annual taxes

- no tax advantage because the gain is treated as capital gains, not dividend income (no dividend tax credit)

- at maturity, the accrued dividends are treated as interest income

What are Stock Indexes and Averages?

- Stock exchange is a cumulation of stocks (tells you how the economy is doing)

- Used for creating index funds and derivatives

What are the two ways to create stock indexes?

1. market capitalization

2. Stock average (price average)

What is market capitalization?

number of common shares multiplied by the current price of those shares

- considering each firm according to its size

What is the disadvantage of constructing an index according to market capitalization?

- the largest companies have all the say and influence in the index

What is the disadvantage of constructing an index according to stock average (only considering the price of each stock)?

- stocks that have higher stock price will influence the average and have all the influence

What happens to a stock average index when a stock splits?

- if a stock splits, the denominator is adjusted upwards

- if a stock consolidates, the denominator is adjusted downwards

Which index is most similar to the Dow Jones Industrial Average?

The Nikkei (Japan's leading stock index)