Essential Characteristics of Common Stock

1. Essential Characteristics of Common Stock • Common stock are shares in a firm’s ownership • Stockholder is a residual claimant • Limited liability Measuring Stock Market Performance • The Dow Jones Industrial Average • The Standard & Poor's 500 Index • Nasdaq Composite index • Wilshire 5000

3. Fundamental Value: The Dividend-Discount Model

4. Valuing Stocks

5. Valuing Stocks Assume the firm pays dividends forever

6. But you won’t hold stock forever … Return after holding stock one year: • Since the ultimate future sale price is unknown the stock is risky • the investor will require compensation in the form of a risk premium • Required Stock Return (i) = Risk-free Return (rf) + Risk Premium (rp)

7. Dividend Discount Model With Risk • Stock Prices are High When • Current dividends are high (Dtoday is high) • Dividends are expected to grow quickly (g is high) • The risk-free rate is low (rf is low) • The risk premium on equity is low (rp is low)

8. The Theory of Efficient Markets • Prices of all financial instruments, including stocks, reflect all available information • Future price movements are unpredictable. • If you could reliably predict a stock’s price will rise in the future, you would try to buy so much of it now that its price would rise now … and there would be no above-normal gain in the future

9. Jeremy Siegel:Investing in Stocks For the Long Run

10. The Stock Market’s Role in the Economy • Stock prices tell us the market value of companies, which determines the allocation of resources. • Firms with a high stock market value are the ones investors prize, so they have an easier time garnering the resources they need to grow. • In contrast, firms whose stock value is low have difficulty financing their operations

11. The Stock Market and the Economy • Bubbles: persistent and expanding gaps between actual stock prices and those warranted by the fundamentals. • Bubbles inevitably burst, creating crashes.