Key Concepts in Stock Valuation and Dividends

cumulative dividends

A protective feature on preferred stock that requires preferred dividends not paid in previous years to be disbursed before any common stock dividends can be paid.

call premium

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

growth stocks

Stocks that generally pay little or no dividends so as to retain earnings to help fund growth opportunities.

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

A provision that gives existing common stockholders the right to purchase new issues of common stock on a pro rata basis before any shares can be offered to other investors.

income stocks

Stocks of firms that traditionally pay large, relatively constant dividends each year.

classified stock

Common stock that is given a special designation, such as Class A, Class B, and so forth, to meet special needs of the company.

founders' shares

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 traded in U.S. stock markets that represent ownership in stocks of foreign companies and are held in trust by banks located in the countries where the stocks are traded.

Yankee stock

Stock issued by foreign companies and traded in the United States.

Euro stock

Stock traded in countries other than the home country of the company, not including the United States.

intrinsic, or theoretical, value

The value of an asset that, in the mind of a particular investor, is justified by the facts; P^0 can be different from the asset's current market price, its book value, or both.

market price (value)

The price at which a stock currently sells in the market.

growth rate

The expected annual rate of change in dividends per share.

required rate of return

The minimum rate of return stockholders consider acceptable on a common stock.

dividend yield

The next expected dividend divided by the current price of a share of stock, D^1/P0.

capital gains yield

The change in price (capital gain) during a given year divided by the price at the beginning of the year; (P^1-P0)/P0.

P/E ratio

The current per share market price of a stock divided by the earnings per share; P0/EPS0.

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 for the remainder of its life.

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.

expected rate of return

The rate of return an individual stockholder expects to receive on a common stock. It is equal to the expected dividend yield plus the expected capital gains yield, r^s=D^1/P0+(P^1-P0)/P0.

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 bondholders and the stockholders.

market price (value), P0

The price at which a stock currently sells in the market.

intrinsic (theoretical) value, P^0

The value of an asset that, in the mind of a particular investor, is justified by the facts; P^0 can be different from the asset's current market price, its book value, or both.

growth rate, g

The expected annual rate of change in dividends per share.

required rate of return, rs

The minimum rate of return stockholders consider acceptable on a common stock.

expected rate of return, r^s

The rate of return an individual stockholder expects to receive on a common stock. It is equal to the expected dividend yield plus the expected capital gains yield, r^s=D^1/P0+(P^1-P0)/P0.