6 - Valuing Equity Instruments

What is the primary function of an Annual General Meeting (AGM)?

It is an event where managers and directors answer questions from shareholders and shareholders vote on the election of directors and other proposals.

What is a proxy in the context of shareholder rights?

A proxy is an act through which shareholders direct that their shares be voted for them.

How do cumulative preference shares differ from non-cumulative preference shares?

Cumulative preference shares carry forward any unpaid dividends, while non-cumulative preference shares do not accumulate missed dividends.

What is the difference between equity and debt in preference shares?

Debt requires payment of a given rate over a period of time, while equity can allow the company to skip payments depending on the type of share.

What are potential cash flows for a one-year investor?

Potential cash flows include dividends and capital gains from the sale of stock.

How is the dividend yield calculated?

Dividend yield = Dividend/price.

What is a capital gain?

A capital gain is the difference between the expected sale price and the original purchase price for the share.

What contributes to the total return of a share?

Total return is the sum of dividend yield and capital gain rate.

How does the Dividend Discount Model value a stock?

The model shows the present value of all future dividends that the company will pay to the shareholder.

What is the simplest assumption of the Constant Dividend Growth Model?

The simplest assumption is that the dividend grows at a constant rate.

What is meant by retention rate in dividend policy?

The retention rate is the fraction of current earnings that the firm retains, calculated as 1 minus the payout ratio.

What three ways can a firm increase its dividends?

A firm can increase its dividends by increasing its earnings, increasing its dividend payout rate, or decreasing its number of shares outstanding.

Why can’t we use a constant dividend growth model for all stocks?

This model cannot be used if the growth rate is not constant, particularly with young firms that have varying initial earnings growth rates.

What are the limitations of the dividend-discount model?

Limitations include uncertainty in forecasting dividend growth rates, potential for large changes in stock price with small changes in growth assumptions, and the fact that many companies do not pay dividends for extended periods.

What is a total payout model?

The total payout model values all of a firm's equity instead of focusing on a single share and discounts the total amount spent on dividends and share repurchases.