Chapter 14

1. Chapter 14

2. Learning Objectives (part 1 of 3) • Explain what common stock represents • Describe the role of a Board of Directors • Discuss the voting process at an annual meeting • Explain why the payment of dividends is not crucial to an investor

3. Learning Objectives (part 2 of 3) • Indicate why forward and reverse stock splits and stock dividends are usuallymeaningless • Value a share of stock using a simple dividend growth model • Compute the degree of diversification of a portfolio

4. Learning Objectives (part 3 of 3) • Understand what is meant by the different types of stocks • Describe the concept of classes of stock • Define the differences between preferred and common stock • Describe rights, warrants, and put and call options

5. Features of Common Stock • A portion of ownership of the firm (usually an incredibly small percentage) • Privilege to vote at shareholder meetings • Entitlement to any dividends paid • Stocks have par value (like bonds), but this is a meaningless number

6. Board of Directors • Elected by shareholders to represent the shareholder’s interests • Elects its own Chairman of the Board • A position is called a seat • Two types of directors • Inside director: also employed by comp. • Outside director: not an employee

7. Voting at annual meetings • Most shareholders sign proxies • Most common voting system is majority • Ownership or control of 50% + 1 of the voting shares allows complete control of the Board • Alternative system is cumulative voting • Multiply number of seats to be elected by shares held and can cast all for one person

8. Payment of dividends (1 of 3) • Must be declared by Board of Directors each time • Should not be declared if company can keep the profits and reinvest them at a rate of return higher than that required by the shareholders • Successful reinvestment leads to a higher stock price later

9. Payment of dividends (2 of 3) • Key dates • Declaration date • Ex-dividend date • Record date • Payment date

10. Payment of dividends (3 of 3) • Types of dividends • Regular (Same nominal amount paid on a regular quarterly interval • Increase or decrease (paid or normal time, but a different nominal amount) • Irregular • Monthly, semiannual, annual

11. Stock Splits and Stock Dividends (1 of 2) • Splits change the par value and shares adjusted to keep par value owned by an investor constant • Forward split: increases shares outstanding (e.g., 3 x 1 split) • Reverse split: reduces shares outstanding (e.g., 1 x 10 reverse split)

12. Stock Splits and Stock Dividends (2 of 2) • Stock dividends are simply additional shares given to existing shareholders (e.g., a 3% stock dividend) • Neither splits not dividends alter the value of the underlying company (cutting a pie into 2 pieces or 20 pieces does not alter the total size of the pie)

13. Constant dividend growth model • Easiest model for understanding the determinants of stock value • V0 = D1/ (r - g) • V0 = value of the stock today • D1= the value of the dividend expected to be paid in the coming year • r = the appropriate risk-adjusted discount rate • g = the rate at which dividends are expected to grow in the future.

14. Determining Degree of Portfolio Diversification • Woerheide-Persson Index • Compute the percentage weight of each holding • Square each weight • Sum the squared terms • Subtract this sum from one • Compare this value to various values of 1 – 1/n

15. Different types of stocks • People categorize to simplify communication and understanding • No universal definitions or agreement as to how any one stock classified • Common categorizations • Blue chip, Value, Growth, Income, Cyclical, Defensive, Speculative

16. Classes of Common Stock • No universal definition of what a particular class designation means • Common classes: Class A and Class B • Typical distinctions • Differential dividend rates • Different voting power • One convertible into the other

17. Preferred Stock • A cross between a stock and a bond • Dividend rate is fixed, hence there is no growth • Dividends are cumulative if missed • Preferred stock priced like a fixed return investment • Preferred stock is usually callable

18. Rights • Used by some companies to raise new money • Rights distributed free to current investors (usually 1 right per share of common stock held) • Have a short life, and give owner privilege to buy stock at a below market price • Allows investors to retain pro rata ownership

19. Warrants • Similar to rights • allows holders to buy stock from the company at a designated price • Usually have an expiration date (some have no maturity) • Usually issued attached to bonds or given to a lender in exchange for a lower interest rate on the debt

20. Options (1 of 2) • Two types of options • Put option • Call option • Call option allows the holder to buy a fixed number of shares (usually 100) of stock of a designated company at a fixed price (called the exercise price) for a give period of time (expiration date)

21. Options (2 of 2) • Put option allows the holder to sell a fixed number of shares (usually 100) of stock of a designated company at a fixed price (called the exercise price) for a give period of time (expiration date) • Buy a call if expect stock price to go up • Buy a put if expect stock price to go down