chap 6 Flashcards
The Appeal of Common Stocks
Stocks may increase in value over time and generate significant capital gains.
Stocks may provide a periodic income stream through dividends
Stock Price Behavior in Perspective
When the market is strong, you can generally expect to benefit from price appreciation.
–When markets falter, so do investor returns.
–Bad market days are the exception, rather than the rule
Stock returns:
take into account both price behavior and dividend income
Stock Prices to Stock Returns , what general pattern happens?
Big returns (or losses) come from capital gains, rather than from dividends.
Stocks generally earn positive returns over long periods of time:–From 1930 to 2014, the average total return on the S&P 500 was 11.4% per year.
Investing in stocks is clearly not without risk:–In 2008, the S&P 500 lost roughly 36% of its value.–From 2000 through 2009, the U.S. stock market’s average annual return was only 1.1% per year.
Average market performance of stocks give a benchmark against which to assess current stock returns and our own expectations
The Advantages of Stock Ownership
Provide opportunity for substantial returns
Stocks typically outperform bonds, and usually by a wide margin.
–Over the last century, stocks earned annual returns roughly double that of the returns provided by high-grade corporate bonds.
Stocks provide protection from inflation because over time their returns exceed the inflation rate.Stocks are easy to buy and sell.
Costs associated with trading stocks are modest.
Price and market information is easy to find in the news and financial media.
Unit cost per share of stock is low enough to encourage ownership
The Disadvantages of Stock Ownership
Stocks are subject to various types of risk:
–Business risk –Financial risk –Purchasing power risk –Market risk –Event risk
Stock returns are highly volatile and very hard to predict, so it is difficult to consistently select top performers.
Stocks generally distribute less current income compared to other investment alternatives.
–Bonds pay more current income and do so with much greater certainty
Equity capital:
every share of common stock represents an equity (ownership) position in a company. This is why stocks are sometimes called “equity securities”.
–Common Stock as a Corporate Security
–Buying and Selling Stocks
–Common Stock Values
Publicly traded issues:
shares of stock that are readily available to the general public and that are bought and sold in the open market.
Public offering:
an offering to sell to the investing public a set number of shares of a firm’s stock at a specified price
Rights offering:
Existing stockholders are given the first opportunity to purchase new shares of the company’s stock in proportion to his or her current ownership position.
Stock spin-off:
conversion of one of a firm’s subsidiaries or divisions to a stand-alone company by distribution of stock in the new company to existing shareholders
Stock split:
when a company increases the number of shares outstanding by exchanging a specified number of new shares of stock for each outstanding share.
Treasury stock:
shares of stock that were originally sold by the company and have been repurchased by the company. Share repurchases are often called “buybacks.”
Reduces the number of shares outstanding to the public.
Kept by the corporation and may be used later for mergers, acquisitions, to pay stock dividends or to meet employee stock option plans.
–Companies buyback when they believe their stock is undervalued and a good buy.
–Companies also repurchase shares as an alternative to paying dividends.
–Short-term impact usually positive: stock prices generally go up
Classified Common Stock:
common stock issued in different classes, each of which entitles holders to different privileges and benefits
Market capitalization:
total number of shares outstanding multiplied by the share price (market value per share)
Bid-ask spread
difference between the bid and ask prices for a stock
Par Value
arbitrary amount assigned to a stock when it is first issued.
Set very low, representing a minimum value (floor) for the value of the stock.
Mainly an accounting term and not very useful to investors
Book Value:
Stockholders’ equity in the firm as reported on the balance sheet.
Accounting term
Difference between the company’s assets and liabilities (less any preferred stock)
Backward-looking estimate of value
Market Value
the current price of the stock in the stock market.
Forward-looking, reflecting investors’ expectations about how the company will perform in the future.
Stocks usually trade at market prices that exceed their book values, sometimes to a very great degree.
When a stock’s market value drops below its book value, the firm is usually dealing with some sort of financial distress and doesn’t have good prospects for growth
Investment Value:
he amount that investors believe the stock should be trading for, or what they think it is worth.
Probably the most important measure for a stockholder.
Determined by a complex process of evaluating risk and return information to place a value on the stock that represents the maximum price an investor should be willing to pay for the issue.
Dividend income
is one of the two basic sources of return to investors. Dividends represent the return of part of the profit of the company to the owners (the stockholders)
more predictable than capital gains, so it is preferred by investors seeking lower risk
Current tax laws put dividends on the same plane as capital gains; both now are taxed at the same rate
The Dividend Decision
A firm’s board of directors evaluates the firm’s operating results and financial condition to determine whether dividends should be paid out and in what amount.
Earnings Per Share:
the amount of annual earnings available to common stockholders, stated on a per-share basis
Date of record:
date on which the investor must be a registered shareholder of the firm (holder of record) to be entitled to a dividend.
