stock outline

Stocks

  • Definition: Stocks are a common type of investment that represent ownership in a company.
  • Ownership Rights: As a stockholder, you are entitled to a share of the company's profits. However, the company may choose to reinvest these profits for growth rather than distribute them.
  • Dividends: To maintain value, a company must eventually distribute some of its earnings to shareholders, termed dividends.
  • Valuation of Stocks:
    • Growth Rates: Used to estimate future dividends' size.
    • Discount Rate: Used to calculate the present value of future dividends.
    • Investment Decision Criteria:
    • Undervalued Stock: If the present value of future dividends exceeds the market price, the stock is considered undervalued and should be bought.
    • Overvalued Stock: If the present value of future dividends is less than the market price, the stock is overvalued and should not be purchased.

Stock Terminology

I. Stock Terminology
a. Stock: Represents ownership in a company.
b. Dividends: Payments made by a company to its shareholders from its earnings.
c. Market Capitalization: The total market value of a company's outstanding shares.

Stock Valuation

II. Stock Valuation
a. Discount Rate: The interest rate used to determine the present value of future dividends.
b. Growth Rate: The rate at which future dividends are expected to grow.
c. Terminal Value:
i. Long-Term Growth: The growth rate applied for estimating a company's cash flow beyond the projection period.
ii. Gordon Growth Model: A model used to determine the intrinsic value of a stock based on its future dividend payments that are expected to grow at a stable rate.
d. Solving for Intrinsic Value: Dividend Discount Model (DDM):
i. Write down the growth rate of dividends.
ii. Calculate forecasted dividends for the projection period.
iii. Calculate the terminal value for the dividends beyond the forecast period.
iv. Discount the cash flows to their present value.
v. Calculate intrinsic value.
e. Compare to Market Price: After calculating intrinsic value, compare it to the current market price to determine if the stock is overvalued or undervalued.
f. Relation between Dividends, Intrinsic Value, and Market Price: Higher dividends typically result in a higher intrinsic value.

Stock Returns

III. Stock Returns
a. Dividend Yield: The annual dividend payment divided by the market price of the stock, expressed as a percentage.
ext{Dividend Yield} = rac{ ext{Annual Dividends}}{ ext{Market Price}}
b. Capital Gain Yield: The price appreciation of a stock, indicating the percentage increase in stock price over a period of time.
c. Total Return: The combined return from dividend yield and capital gains.

Stock Risk

IV. Stock Risk

  • Stocks are generally riskier investments than bonds.
  • The risks associated with stocks are often not fully understood, making it challenging to determine the appropriate required return for a stock.

Stock Characteristics

V. Stock Characteristics
a. Approximately 7,000 publicly traded stocks exist in the market.
b. About half of these publicly traded stocks pay dividends
c. The majority of stocks that pay dividends do so quarterly, or four times a year.
d. Stocks are more liquid than bonds, meaning they can be traded more easily.
e. Stocks carry a higher risk compared to bonds, which makes them more uncertain investments.

Types of Stocks

VI. Types of Stocks
a. By Voting and Distribution Rights
i. Common Stock: Provides voting rights and possible dividends.
ii. Preferred Stock: Typically has no voting rights but offers fixed dividends.
b. By Market Capitalization (Size)
i. Large-Cap: Companies with a large market capitalization.
ii. Mid-Cap: Companies with a medium market capitalization.
iii. Small-Cap: Companies with a small market capitalization.
iv. Micro-Cap: Companies with a very small market capitalization.