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Transcript of [email protected] 1. 2 Contents What is Stocks? Classification of Stocks; Rights and...
ContentsWhat is Stocks? Classification of Stocks; Rights and privileges of Common Stock holder and Preferred stock holder, Stock valuation models, valuations of stocks, Zero growth, Constant and Non-Constant Growth Models. Finding the price of the stock, calculating he growth rate, calculating the dividend yield, capital gains yield, Required return etc.
The Stock Markets terms and issue; Stock Exchanges, SEC of Bangladesh and OTC market, The Primary markets: New issues, IPO, Investment banker, Underwriting, Syndicate, Private placement, Secondary market, Listing, and Efficient market Hypothesis.
• A Stock is an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation's assets and profits.
• Stock also known as share. • Ownership in the company is determined by the
number of shares a person owns divided by the total number of shares outstanding.
• For example, if a company has 1000 shares of stock outstanding and a person owns 50 of them, then he/she owns 5% of the company.
Types of Stocks
01. Common Stocks: Common stock is a type of stock which represents ownership in a corporation.
Securities representing equity ownership in a corporation, providing voting rights, and entitling the holder to a share of the company's success through dividends and/or capital appreciation. In the event of liquidation of, common stockholders have rights to a company's assets only after bondholders, other debt holders, and preferred stockholders have been satisfied.
02. Preferred stocks: A special form of stock having a fixed periodic dividend that must be paid prior to payment of any common stock dividends.Preferred stock, is a hybrid form of financing, sharing some features with debt and some with common equity. For example, preferred dividends like interest payments on debt are generally fixed. In addition, the claims against the assets of the firm of the preferred stockholders, like those of the debt holders, are also fixed.
When is a stock sale an initial public offering (IPO)?
• A firm “goes public” through an IPO when the stock is first offered to the public.
• Prior to an IPO, shares are typically owned by the firm’s managers, key employees, and, in many situations, venture capital providers.
Common Shareholders' Rights and Privileges
1. The right to receive dividend payments2. The power to sell the stock 3. The right to vote to elect directors 4. Residual ownership5. The right to receive a proportionate
distribution of assets on corporate liquidation
6. Residual claim on income and assets7. Limited Liability8. No maturity date
Characteristics of Preferred Stock• Dividends: Owners of preferred stock receive payment of dividends before the owners of common stock.
• Fixed dividend payment (similar to bond interest payment)• Convertibility: Often, preferred stock can be changed or converted into common stock.
• Callability: Company can contact the owners of preferred stock and force them to sell it back to the company for either cash or common stock.
• Bankruptcy: Priority to take…• Less Volatility: Preferred stock generally does not move up or down as fast as common stock. This means it is less volatile.
• No maturity date• Do Not Have Voting Rights: Preferred stockholders do not have voting rights (like common stockholders do)
Terms related to Share: Book value per share
Book value per share is simply the amount per share of common stock that would be received if all of the firm’s assets were sold for their exact book (accounting) value and the proceeds remaining after paying all liabilities (including preferred stock) were divided among the common stockholders.
Example: At year-end 2010, Lamar Company’s balance sheet shows total assets of $6 million, total liabilities (including preferred stock) of $4.5 million, and 100,000 shares of common stock outstanding. Calculate Book Value per share.
StockCommon ofNumber
sLiabilitie -Assest of Value BVPS
=
Terms Related To Share: Liquidation Value Per Share
Liquidation value per share is the actual amount per share of common stock that would be received if all of the firm’s assets were sold for their market value, liabilities (including preferred stock) were paid, and any remaining money were divided among the common stockholders. This measure is more realistic than book value—because it is based on the current market value of the firm’s assets—but it still fails to consider the earning power of those assets
Example: Lamar Company found upon investigation that it could obtain only $5.25 million if it sold its assets today. It has total liabilities (including preferred stock) of $4.5 million, and 100,000 shares of common stock outstanding. Calculate liquidation value per share.
StockCommon ofNumber
ValueStock Preferred - sLiabilitie -Assest of ValueMarket LVPS
=
Financial and Non-Financial Factors Affecting Stock Prices
1. Dividends2. Disclosure of Financial
informationa) Periodic Reportb) EPSc) NAVd) NOCFse) P/Ef) Spliting the Face Value
3. Disclosure of Organizational Plana. New Product, Production
Plan and Plantb. Merging or Take over of
other company
4. Financial Plana) Right Issueb) Preferred Stock Issuec) Bond Issued) Other Debt financing
5. Political Situation6. Rumor7. Lack of confidence8. Category Change9. Trading market Change10.Trade Suspension11.Sue or cases12.Government Regulators’
Attitude towards a company
Types of Stock Dividends• Cash dividends: A cash dividend is a dividend paid
for in cash. To be able to pay dividends in cash, companies not only need to have enough profits, but to have enough cash
• Stock dividend: Companies, not having good cash position, generally pay dividend in the form of shares by capitalizing the profits of current year and of past years. Such shares are issued instead of paying dividend in cash and called 'Bonus Shares'.
• Property dividends: Sometimes, dividend is paid in the form of asset instead of payment of dividend in cash. The distribution of dividend is made whenever the asset is no longer required in the business such as investment or stock of finished goods.
Example 03: Calculating the Return of a Common Stock
The common stock of Alton Industries (AI) is currently selling for $50 per share, and market participants expect it to generate benefits of $6.50 per share during each coming period. In addition, the risk-free rate, RF, is currently 7%; the market return, km, is 12%; and the stock’s beta, bAI, is 1.20. What will be the firm’s current expected return?
What is a stock Market?The system in which communication networks, financial institutions and relevant rules and regulations are established and activated in order to facilitate smooth flow of funds and corresponding financial instruments/assets.
The building or place where stocks are bought and sold is known as stock market or Stock Exchange.
Types of Stock Markets/Exchange
• Physical location stock exchanges (Organized Market)• Electronic dealer-based markets (OTC Market)
Bangladesh have two stock market: DSE (1954) and CSE (1995).
Functions of a Stock market/Exchanges1. The first function is to provide companies with a
way of issuing shares to people who want to invest in the company.
2. Provide its members with the premises, systems and mechanisms which furnish them with clear information on the purchase and sales bids of the securities, the impartial execution of the respective instructions and the efficient settlement of their operations.
3. Promote the trading of securities, carrying out the necessary activities and offering the appropriate services for such purposes to ensure permanent growth of the market.
4. Offer information to the general public regarding stockbrokerage houses, stock brokers and market transactions.
Functions of stock Exchange….5. Register, in accordance with the legal provisions and
regulations, the stock and securities to be traded and the respective operations.
6. Divulge and keep the general public up to date on the information concerning stock values, and the financial situation and other circumstances of the equity issuers.
7. Supervise that its members or their representatives act in accordance with the accepted commercial ethics, and the respective legal dispositions, regulations and statutes.
8. Publish information on the Stock Market and any other information related to stockbroking activities.
Functions of stock exchange….9. Certify the value of the securities traded on the
Exchange.10. Investigate new facilities or products which may be
offered to either current investors or potential investors and equity issuers,
11. Establish and implement other complementary and compatible services.
12. Carry out all other acts necessary to comply with the objectives of the Exchange.
13. Create subsidiaries for those purposes established by the General Members Assembly; and others as indicated by legal dispositions and these statutes.
Question: Discuss the major functions and activities of Dhaka Stock Exchange (DSE).
Example 04: Preferred dividends Slater Lamp Manufacturing has an outstanding issue of preferred stock with an $80 par value and an 11% annual dividend.
a. What is the annual dollar dividend? If it is paid quarterly, how much will be paid each quarter?
b. If the preferred stock is noncumulative and the board of directors has passed the preferred dividend for the last 3 quarters, how much must be paid to preferred stockholders before dividends are paid to common stockholders?
c. If the preferred stock is cumulative and the board of directors has passed the preferred dividend for the last 3 quarters, how much must be paid to preferred stockholders before dividends are paid to common stockholders?
Solutionsa. $8.80 per year or
$2.20 per quarter
b. $2.20 For a noncumulative preferred only the latest dividend has to be paid before dividends can be paid on common stock.
c. $8.80 For cumulative preferred all dividends in arrears must be paid before dividends can be paid on common stock. In this case the board must pay the 3 dividends missed plus the current dividend.
Example 05: Preferred dividends In each case in the following table, how many dollars of preferred dividends per share must be paid to preferred stockholders before common stock dividends are paid?
Case Type Par Value DPS per period Periods of Div. passed
A Cumulative $80 $5 2
B Noncumulative 110 8% 3
C Noncumulative 100 $11 1
D Cumulative 60 8.5% 4
E Cumulative 90 9% 0
Results:A $15.00 2 quarters in arrears plus the latest quarterB $8.80 only the latest quarterC $11.00 only the latest quarterD $25.50 4 quarters in arrears plus the latest quarterE $8.10 only the latest quarter
Convertible preferred stock
Valerian Corp. convertible preferred stock has a fixed conversion ratio of 5 common shares per 1 share of preferred stock. The preferred stock pays a dividend of $10.00 per share per year. The common stock currently sells for $20.00 per share and pays a dividend of $1.00 per share per year.
a. Judging on the basis of the conversion ratio and the price of the common shares, what is the current conversion value of each preferred share?
b. If the preferred shares are selling at $96.00 each, should an investor convert the preferred shares to common shares?
c. What factors might cause an investor not to convert from preferred to common?
Solution: Convertible preferred stock
a. Conversion value = conversion ratio x stock price = 5 x $20 = $100
b. Based on comparison of the preferred stock price versus the conversion value the investor should convert. If converted, the investor has $100 of value versus only $96 if she keeps ownership of the preferred stock.
c. If the investor converts to common stock she will begin receiving $1.00 per share per year of dividends. Conversion will generate $5.00 per year of total dividends. If the investor keeps the preferred they will receive $10.00 per year of dividends. This additional $5.00 per year in dividends may cause the investor to keep the preferred until forced to convert through use of the call feature.
Stock Valuation is more difficult than Bond Valuation because stocks do not have a finite maturity and the future cash flows, i.e., dividends, are not specified. Therefore, the techniques used for stock valuation must make some assumptions regarding the structure of the dividends.
1. Zero dividend growth model: The zero dividend growth model assumes that the stock will pay the same dividend each year, year after year.
2. Constant Growth Model: The constant dividend growth model assumes that the stock will pay dividends that grow at a constant rate each year, year after year.
3. Non-Constant Growth Model: The non-constant (variable) dividend growth model assumes that the stock will pay dividends that grow at one rate during one period, and at another rate in another year or thereafter.
Constant Growth Model Equation
gk
gDP
s
10
0
Where:P0 = the stock price at time 0/ Current price of the stock/
present value of the stock/ Selling price of the stock D0 = the current dividend, (recently paid dividend)
D1 = the next dividend (i.e., at time 1), g = the growth rate in dividends, and Ks = the required return on the stock, and g < Ks.
What will be the formula is g=0?
D D gD D gD D gt 0
t
1 01
2 02
111
gk
DP
s 1
0or
What happens if g > ks?
• If ks< g, get negative stock price, which is nonsense.
• We can’t use model unless (1) g ks and (2) g is expected to be constant forever. Because g must be a long-term growth rate, it cannot be ks.
.k requires s1
0 ggk
DP
s
What is a Zero Growth Stock?
• If a stock is expected to pay a constant, non-growing dividend, each dollar dividend is the same is called Zero growth stock. A zero growth stock is a perpetuity to the investor
• Gordon model simplifies to: 0
DP
k
2.00 2.002.00
0 1 2 3ks=13%
D
k
$2.00
0.13P0 = = = $15.38
Example 06: The Zero Growth Rate Case
Example 07: Stock Value under Zero Growth Model
The dividend of Denham Company, an established textile producer, is expected to remain constant at $3 per share indefinitely. If the required return on its stock is 15%, what will be the value of the stock?
gk
DP
s 0
Answer: $20
20$%0%15
3$0
s
P
Example 08: Price of a Stock (Constant Growth Model)
Suppose a corporation just paid a dividend of $0.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the stock be selling for?
$3.92
.02)(0.15
0.02)0.50(1
gs
k1
D
0P
Here, Do = $.50G = 2% Ks = 15% D1 = ?Po = ?
Example 09: Constant Growth -The Gordon Mode
Atlas Motors is expected to grow at a constant rate of 6% a year into the indefinite future. It recently paid a dividends of $2.25 a share. The rate of return on stocks similar to Atlas is about 11%. What should a share of Atlas Motors sell for today?
10
DP
k - g
$2.25 (1.06)
.11 - .06$47.70
Practice 01(a). Calculate the stock’s market value if D0 = 2.00, ks = 13% and g = 6%.
29.30$07.0
12.2$
06.013.0
12.2$
gk
DP
s 1
0
Practice 01(b). What is the stock’s market value one year from now (P1) if D0 = 2.00, ks = 13% and g = 6%?
gk
DP
s 2
110.32$
07.0
2472.2$
Practice 01(c). Find the expected dividend yield and capital gains yield during the first year.
Dividend yield = D1
P0
Capital Gains Yield = P1 - P0
P0
Dividend yield = = = 7.0%.$2.12
$30.29
D1
P0
CG Yield = =P1 - P0
P0
$32.10 - $30.29
$30.29
= 6.0%.
Practice 01(d): Find the total return during the first year
Total return = Dividend yield + Capital gains yield.
Total return = 7% + 6% = 13%.
Total return = 13% = ks.
For constant growth stock: Capital gains yield = 6% = g.
.k to s gP
D
gk
DP
s
0
110
Rearrange model to rate of return form:
Then, ks = $2.12/$30.29 + 0.06= 0.07 + 0.06 = 13%.
Practice 02: Calculating Total Return
Given that D0 = 12.00, ks = 15% and g = 9%. Calculate the followings:
1. Calculate D1, D2, D3, D4
2.Calculate P1, P2, P3, P4
3.Calculate Dividend Yield at the end of Year 01
4.Calculate Capital Gains Yield at the end of Year 01
5.What is the total Return at the end of year 01
Practice 03: Finding the Missing Factor
Ewald Company’s current stock price is $36, and its last dividend was $2.40. In view of Ewald’s strong financial position and its consequent low risk, its required rate of return is only 12 percent. If dividends are expected to grow at a constant rate (g), in the future, what is Ewald’s expected stock price five years from now?
0
0
0
1 gor 1 P
gDsk
P
Dsk g
• g = 5%
• P5 =$45.95
Practice 04-06: Calculating the Growth Rate
1.28%
06. Find the dividend growth rate for a stock given that the next dividend is $3.06 per share, the required return is 8.85%, and the stock price is $40.42 per share.
7.03%
05. Find the dividend growth rate for a stock given that the current dividend is $1.45 per share, the required return is 9.45%, and the stock price is $64.13 per share.
1.75%
04. Find the dividend growth rate for a stock given that the next dividend is $2.04 per share, the required return is 12.37%, and the stock price is $19.21 per share.
Practice 07-09 : Calculating the Required Return
.k 0
1s g
P
D
15.9%
09. Find the required return for a stock given that the current dividend is $1.33 per share, the dividend growth rate is 9.23%, and the stock price is $21.78 per share.
14.69%
08. Find the required return for a stock given that the next dividend is $5.72 per share, the dividend growth rate is 5.9%, and the stock price is $65.07 per share.
11.64%
07. Find the required return for a stock given that the current dividend is $3.13 per share, the dividend growth rate is 5.77%, and the stock price is $56.4 per share.
Practice- 10: Gordon ModelUse the constant-growth model (Gordon model) to find the value of each firm shown in the following table:
Firm D1 g Ks
A $ 1.20 8% 13%
B $ 4.00 5% 15%
C $ 0.65 10% 14%
D $ 6.00 8% 9%
E $ 2.25 8% 20%
a. $24b. $40.00e. $18.75
Practice Problem 12: Calculating Growth Rate
McCracken Roofing, Inc., common stock paid a dividend of $1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5% per year for the foreseeable future.
a. What required rate of return for this stock would result in a price per share of $28?
b. If McCracken had both earnings growth and dividend growth at a rate of 10%, what required rate of return would result in a price per share of $28?
Solution : Practice Problem
a.
%5.9095.05.045.05.28$
26.1$k
05.28$
)05.1(20.1$k
gP
Dk
s
s
0
1s
b.
%7.14147.10.047.10.28$
32.1$k
10.28$
)10.1(20.1$k
s
s
Practice Problem 13
Year DPS
2009 $2.87
2008 2.76
2007 2.60
2006 2.46
2005 2.37
2004 2.25
a. If you can earn 13% on similar-risk investments, what is the most you would be willing to pay per share?
b. If you can earn only 10% on similar-risk investments, what is the most you would be willing to pay per share?
c. Compare and contrast your findings in parts a and b, and discuss the impact of changing risk on share value.
Elk County Telephone has paid the dividends shown in the following table over the past 6 years. The firm’s dividend per share next year is expected to be $3.02.
Solution: Practice Problem 13Computation of growth rate:FV = PV x (1 + g)n $2.87 = $2.25 x (1 + g)5 g = 5%
a. Value at 13% required rate of return:
75.37$05.13.
02.3$P0
b. Value at 10% required rate of return: 40.60$
05.10.
02.3$P0
c. As risk increases, the required rate of return increases, causing the share price to fall.
$2.87 $2.76 $2.60 $2.46 $ 2.37 $2.25
2004 2005 2006 2007 2008 2009
n Ks1
1
cgKs1nD
..........3Ks)(1
3D
2Ks)(1
2D
1Ks)(1
1D
0P
where
P0 = the stock price at time 0,
Dt = the expected dividend at time t, n = the number of years of
nonconstant growth,
gc=the long-term constant growth rate in dividends, and
r = the required return on the stock, and gc < r.
g)(1DD
g)(1DD
g)(1DD
g)(1DD
34
23
12
01
Dividend Formula for Non-Constant Model
Example 10: Nonconstant Growth Stock Valuation
The current dividend on a stock is $2 per share and investors require a rate of return of 12%. Dividends are expected to grow at a rate of 20% per year over the next three years and then at a rate of 5% per year from that point on. Find the price of the stock.
80.43$
312.01
105.03)12.0(1
3.4562)12.0(1
$2.881)12.0(1
$2.400P
12.0
6288.3
3 Ks1
1
cgKsD
3Ks)(1
3D
2Ks)(1
2D
1Ks)(1
1D
0P 4
Hints:1. At First calculate D1, D2, D3 and D42. Then Put the value into below formula
Practice Problem: 11• Perry Motors’ common stock currently pays an annual
dividends of $1.80 per share. The required return on the common stock is 12%. Estimate the value of the common stock under each of the following assumptions about the dividend.
1. Dividends are expected to grow at an annual rate of 0% to infinity.
2. Dividends are expected to grow at a constant annual rate of 5% to infinity.
3. Dividends are expected to grow at an annual rate of 5% for each of the next 3 years, followed by a constant annual rate of 4% in years to infinity.
1. $ 152. D1 = $1.89, Po = $273. $23.97
Example 12: Nonconstant Growth Stock Valuation
Find the price for a stock given that the required return is 11.2%, the current dividend is $3.33 per share, dividends are expected to grow at a rate of 6% during year 1, dividends are expected to grow at a rate of 6% during year 2, dividends are expected to grow at a rate of 6% during year 3, and dividends are expected to grow at a rate of 5% per year from that point on.
Answer: $57.93
For more stock valuation practice, please visit the following websites:http://www.zenwealth.com/BusinessFinanceOnline/SV/SGStockExercise.html
• The efficient market hypothesis states that at any given time, security prices fully reflect all available information.
• Efficient Market: An efficient market is defined as a market where there are large numbers of rational, profit-maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants.
1. The Weak Form asserts that all past market prices and data are fully reflected in securities prices. In other words, technical analysis is of no use.
2. The Semi-strong Form asserts that all publicly available information is fully reflected in securities prices. In other words, fundamental analysis is of no use.
3. The Strong Form Asserts that all information is fully reflected in securities prices. In other words, even insider information is of no use.
Sample Question 01: What is the difference between a venture capitalist (VC) and an angel capitalist (angel)?
Venture capitalists are typically business entities that are organized for the purpose of investing in attractive growth companies.
Angel capitalists are generally wealthy individuals that provide private financing to new businesses. Firms usually obtain angel financing first, then as their funding needs get too large for individual investors they seek funds from venture capitalists.
Sample Question 02: Describe, compare, and contrast the following common stock dividend valuation models: (a) zero-growth, (b) constant-growth, and (c) variable growth.
a. The zero growth model of common stock valuation assumes a constant, nongrowing dividend stream. The stock is valued as a perpetuity and discounted at a rate ks:
b. The constant growth model of common stock valuation, also called the Gordon model, assumes that dividends will grow at a constant rate, g. The stock is valued as the present value of the constantly growing cash flow stream:
c. The variable growth model of common stock valuation assumes that dividends grow at a variable rate. The stock with a single shift in the growth rate is valued as the present value of the dividend stream during the initial growth phase plus the present value of the price of stock at the end of the initial growth phase:
sk
PP
00
gk
DP
s
10
)()1(
1
1 )1(
)1(
2
1100
gk
D
k
N
t k
gDP
s
N
Ns
ts
t
Home Practice
1. Find the price for a stock given that the current dividend is $2.82 per share, the required return is 13.27%, the growth rate is dividends is 8.85% per year.
2. Find the required return for a stock given that the current dividend is $3.04 per share, the dividend growth rate is 2.07%, and the stock price is $69.57 per share.
3. Find the required return for a stock given that the next dividend is $4.81 per share, the dividend growth rate is 2.74%, and the stock price is $87.93 per share.
4. Find the dividend growth rate for a stock given that the current dividend is $5.27 per share, the required return is 7.46%, and the stock price is $105.12 per share.
Home Practice
5. Find the dividend growth rate for a stock given that the next dividend is $5.1 per share, the required return is 14.23%, and the stock price is $71.03 per share.
6. Find the current dividend on a stock given that the required return is 10.17%, the dividend growth rate is 7.81%, and the stock price is $268.15 per share.
7. Find the price for a stock given that the next dividend is $2.39 per share, the required return is 9.87%, the growth rate is dividends is 6.28% per year.
8. Find the next dividend (D1) on a stock given that the required return is 8.92%, the dividend growth rate is 3.13%, and the stock price is $58.89 per share.
Home Practice9. Find the price for a stock given that the required return is 9.1%,
the current dividend is $2.63 per share, dividends are expected to grow at a rate of 6% during year 1, dividends are expected to grow at a rate of 19% during year 2, and dividends are expected to grow at a rate of 6% per year from that point on.
10. Find the price for a stock given that the required return is 14.3%, the current dividend is $2.46 per share, dividends are expected to grow at a rate of 18% during year 1, dividends are expected to grow at a rate of 9% during year 2, dividends are expected to grow at a rate of 3% during year 3, and dividends are expected to grow at a rate of 7% per year from that point on.
11. Find the price for a stock given that the required return is 14.1%, the current dividend is $2.63 per share, dividends are expected to grow at a rate of 6% during year 1, dividends are expected to grow at a rate of 4% during year 2, dividends are expected to grow at a rate of 6% during year 3, dividends are expected to grow at a rate of 15% during year 4, and dividends are expected to grow at a rate of 8% per year from that point on.
