CHAPTER 8: Equity Securities - Common & Preferred Shares

8.1 Introduction

• Content Source: The slides for this course are adapted from the Canadian Securities Institute (CSI) and modified by Fanshawe College.

• Recommendation: Students should read the textbook chapters thoroughly and utilize online learning resources for comprehensive understanding.

8.2 Overview of Topics

• Common Shares

• Preferred Shares

• Stock Indexes and Averages

8.3 Chapter Highlights

• Purchasing common or preferred shares signifies an ownership stake in a company.

• Returns on investment are linked to company performance.

• Volatility in interest rates primarily affects corporate bonds; bondholders receive priority over shareholders in bankruptcy.

8.4 Common Shares

8.4.1 Reasons for Purchasing Common Shares

• Ownership Stake: Investors gain a direct ownership interest.

• Capital Growth: Potential for increasing value of shares over time.

• Profit Sharing: Investors may receive dividends based on company profitability.

8.4.2 Rights and Advantages of Common Shares

• Potential for Capital Appreciation: Value of shares can increase significantly.

• Dividends: Shareholders may receive dividends, though they are not guaranteed.

• Tax Treatment: Favorable tax treatment for dividends and capital gains.

• Voting Privileges: Shareholders generally have the right to vote on corporate matters.

• Limited Liability: Investors' liability is limited to the amount invested in shares.

• Marketability: Common shares can be bought and sold easily in markets.

8.4.3 Understanding Dividends

• Payment Conditions: Dividends are not contractual; they are declared by the board.

• Record Date: Shareholders on record receive dividends, typically declared weeks in advance.

• Ex-Dividend and Cum Dividend: Determines who is entitled to the upcoming dividend based on purchase timing relative to record date.

• Types of Dividends: Regular, extra, and stock dividends vary in form and frequency.

8.5 Restricted Shares

• Shares that participate in earnings but may lack voting rights.

8.5.1 Types of Restricted Shares

• Non-Voting: No voting rights except in special circumstances.

• Subordinate Voting: Voting rights exist but are inferior to another class of shares.

• Restricted Voting: Voting subject to limitations on the number or percentage of shares voted.

8.6 Stock Splits and Consolidations

8.6.1 Stock Splits

• Purpose: Adjust share prices to a more attractive range.

• Example: A 2-for-1 split means holding twice as many shares at half the price.

8.6.2 Consolidations or Reverse Splits

• Purpose: Increase share price to improve refinancing capacity.

• Example: A 1-for-10 split means fewer shares at a higher price.

8.7 Preferred Shares

8.7.1 Characteristics of Preferred Shares

• Preference in Payments: Dividends are paid before common shares.

• Business Failure Priority: Preferred shares have a higher claim than common shares during liquidation.

8.7.2 Reasons for Issuing Preferred Shares

• Flexibility for companies with high debt-to-equity ratios.

• Fixed returns for investors without diluting common share earnings and voting control.

8.7.3 Investor Advantages and Risks

• Advantages: Steady cash flows with preferential tax treatment and ranking.

• Risks: Vulnerability to purchasing power risk, interest rate hikes, and potential company failure.

8.7.4 Types of Preferred Shares

• Convertible: Can be converted into common shares.

• Retractable: Provides a buyback option on a specified date.

• Floating-Rate or Variable Rate: Dividends change with interest rate fluctuations.

• Foreign Pay: Dividend is in foreign currency, leading to exchange risk.

8.8 Stock Indexes and Averages

8.8.1 Definition and Functions

• Stock Index: A numerical series measuring percentage changes in stock prices over time.

• Importance: Helps investors gauge performance and market trends.

8.8.2 Types of Stock Indexes

• Value-Weighted Indexes: Companies with larger market caps impact changes more significantly.

• Arithmetic Average: Represents the average price of a selection of stocks.

8.8.3 Major Market Indexes

• Canadian Indexes: S&P/TSX Composite, S&P/TSX 60, etc.

• U.S. Indexes: S&P 500, Dow Jones, NASDAQ, Value Line.

• International Indexes: Nikkei 225, FTSE 100, DAX, CAC 40.

8.9 Summary

• Common shares offer capital gains, dividends, and voting rights, while preferred shares are favored for predictable income and tax benefits.

• Preferred shares have prioritization over common shares and provide companies with alternatives to traditional debt.

• Stock indexes serve as benchmarks for overall market performance.