chpapter 7 - stocks

What is stocks?

• A corporation is owned by shares of stock.

• Public companies sell stock on the stock market, where people can buy and sell easily.

• Stocks determine ownership and the market price shows what investors think the company is worth

What are the 2 main types of stock?

Common stock and preferred stock

Stock quotes

the basic information you see about a stock’s price and trading activity.

A stock quote usually includes things like:

• Current price – How much 1 share costs right now


• Price change – How much it went up or down today


• Open price – What it started at this morning


• High/Low – The highest and lowest price during the day

• 
52-week high/low – Highest and lowest price in the past year


• Volume – How many shares were traded today

• 
Ticker symbol – The short code for the company (ex: NKE = Nike

_____ make decisions that influence stock price

Financial managers

Stock prices change daily based on:

supply and demand, company results, and expectations.

Example: Nike’s stock price moves over time because of new decisions and past results.

What is common stock?

When you buy common stock, you become a part-owner of the company.
The more shares you own → the more power and benefits you get.

The rights to common stock holders

Vote (voice in the company)

Attend annual meetings

Vote by proxy

Right to dividends

Right to assets if company goes bankrupt

What do common stock holders vote on and what are the 2 types of voting systems

Shareholders vote on:

• Who becomes a director (board members)

• Major company decisions

More shares = more votes

1.Straight Voting (one share = one vote per director)

• Straight voting is a method of voting for a company’s board of directors where a shareholder gets:

  1 vote per share per seat

  …and must allocate those votes separately for each board seat.

  You cannot pool or combine your votes toward one candidate.

2. Cumulative Voting (more fair for minority)

• Total votes = number of directors × number of shares.

• You can put all your votes on one person if you want.

Classes of common stock and why is this done?

Some companies create different classes of stock with different voting power.

Example:

• Class A = 1 vote per share

• Class B = 10 votes per share

• Class C = 0 votes

Nike: Class A & B stock.

Google (Alphabet): Class A, B, C.

◦ Public owns Class A.

◦ Founders own Class B (10x voting power).

◦ Class C has NO voting rights.

Why do this? 
Founders keep control even if they don’t own most shares.

Explain right to dividends for common stockholders

• Dividends = company profits shared with shareholders.

• Board of directors decides when and how much.

Explain right to assets if a company goes bankrupt for common stock holders

1. Creditors get paid first.

2. Shareholders split what’s left based on how many shares they own.

Common stock is last in line, but they still have a claim if anything remains.

Voting by proxy as a common shareholder

Most people don’t go in person.
They let someone else (usually management or another shareholder) vote for them using a proxy (permission slip).

Proxy contest

A proxy contest is basically about persuading shareholders (or the people who vote on their behalf, called proxy voters) how to vote on key issues - like which directors to elect, or what company decisions to approve.

What is preferred stock?

Preferred stock is a special type of stock that is like a mix between:

• Common stock (ownership)

• Bonds (fixed payments)

Key idea: Preferred stockholders get paid first before common shareholders.

Main rights of a preferred stockholder

1. Dividends com first

2. No voting rights

3. 2nd in line to claim assets in company bankruptcy

What does it mean when dividends com first to preferred stockholders?

• Preferred shareholders must be paid before common shareholders get anything.

Do preferred stockholders have the right to vote in the company?

Preferred shareholders normally cannot vote or control the company.

They trade control for guaranteed income.

What are the 2 types of preferred stock and their explanation?

Cumulative Preferred Stock (MOST common)

• If the company skips a dividend, it owes it later.

• These unpaid dividends add up (accumulate).

• Company cannot pay common shareholders until all back dividends to preferred are paid.

Preferred holders are protected.

B. Non-Cumulative Preferred Stock (rare)

• If the company skips a dividend… it’s gone forever.

• No catching up.

• After paying current preferred dividends, company can pay common.

Less protection for preferred holder.

Why would someone buy preferred stock?

Because it’s safer and gives steady income.

Preferred stockholders:

• Get paid before common stockholders

• Often receive fixed dividend amounts

• Sometimes can get a board seat if company misses too many payments

Preferred Stock in Bankruptcy

Who gets money first if company fails?

• Bondholders (debt holders)

• Preferred shareholders

• Common shareholders (last in line)

Common stockholders are the riskiest.

Is Preferred Stock Equity or Debt?

Preferred stock is treated as EQUITY (ownership)

What are the two main ways to buy/sell stocks?

Market order and limit order

Explain market order

• You do not set a price.

• You say: “Buy it right now at the best available price.”

• Fastest method (done in milliseconds).

• You might pay slightly more or less than expected depending on current price.

Explain limit order

• You set a maximum price you are willing to pay (if buying)
or a minimum price you want to sell at (if selling).

• Order will only happen if the market reaches your price.

• You may have to wait, or it may never execute.

What is bid and ask

Buy price and selling price

Before buying or selling… how do you decide?

• You must estimate the value of the stock and compare it to the current market price.

What are 2 ways of making money from a stock?

1. Dividends (company pays you cash)

2. Selling the stock later for a higher price

How do you value a stock?

Using the dividend discount model

• A stock’s value = Present value of dividends + future sale price

• Use equity cost of capital (rE) to discount future cash flows in the dividend discount model

If the market value is less than the stock value then,

The stock is undervalued in the market → investors will buy → price will increase

If the market value is more than the stock value then,

stock is overvalued in the market → investors sell → price drops.

What is short sale? And what is the how does it work?

Short sale = betting an stock price will go down

How it works:

• A short sale is when an investor:

  1. Borrows shares they do not own

  2. Sells them in the market at today's price

  3. Buys them back later (ideally at a lower price)

  4. Returns the shares to the lender

  5. The lender keeps the difference as profit

  • If the company pays a dividend while you're short, you must pay that dividend to the lender.

What is Dividend Yield, Capital Gain, and Total Return?

When you own a stock, you can make money in two ways:

1. Dividends → cash the company pays you

2. Capital Gain → when the stock price goes up and you sell it for more

Total return: It’s the total percentage you earn in one year from owning the stock (dividends + price change).

Formula: Total Return = Dividend Yield + Capital Gain Rate

What SHOULD the return be?

The total return of a stock must equal what investors could earn on other investments with the same risk.

Stock return = market return for similar risk

What do you use to “predict” every future dividend forever? And what is the purpose of it?

The constant growth dividend model.

To value a stock by assuming dividend grow forever at a constant rate. It tells you what the stock is worth today if its dividend grow at a constant rate forever.

Alternative to the dividend discount model.

Dividends vs. growth

A company has earnings, and it can do two things with that money:

• Pay it out as dividends to shareholders

• Keep (retain) the money and invest it to grow the business

How can a company increase dividends?

Dividend = EPS × Dividend Payout Rate

So dividends can go up if the company:

1. Increases earnings (net income)

2. Increases % of earnings paid out (payout rate)

3. Reduces number of shares outstanding

If the company wants its stock price to rise, should it:

• Cut dividends now and invest more?

• Or pay more dividends and invest less?

: It depends on how profitable its investments are.
If investments give high returns, it’s better to invest (even if dividends drop now).

• High return on investment → Keep money → Grow → Higher future dividends & stock price

• Low return on investment → Better to pay dividends instead of wasting money

Why we cannot use the constant growth formula at first:

Some companies (especially young ones) grow FAST at the beginning and SLOW DOWN later.

.Young firms often pay no dividends (they reinvest everything).
2.Their growth rate keeps changing until they mature.

So the constant growth formula (Gordon model) doesn’t work right away.

But we can still value the stock using a 2-step method:

Step 1: Value the early years one-by-one (non-constant growth)

Step 2: After the company matures, growth becomes constant

Step 3: Discount everything back to today (PV)

What makes a stock valuable?

1. Profitability

• More profits = more ability to pay dividends

• Dividend forecasts represent future profitability

This shows up in the dividend stream (D)

2. Growth in profitability

• Higher growth in earnings → dividends grow over time

This shows up in g (growth rate)

3. Risk

• Risky stocks must pay investors a higher return

This shows up in rE (equity cost of capital)

True or false: if a company doesn’t pay dividend then the dividend discount model can’t value a stock

True

What is a share repurchase?

A share repurchase / stock buyback = the company uses cash to buy back its own shares.

What is the total payout model?

The Total Payout Model values a company by discounting all cash paid to shareholders—both dividends and share repurchases—then dividing by the number of shares outstanding. It measures the value of the entire equity, not just dividends (dividend discount model)