Chapter 1 - Equity Securities Flashcards
Common Stock
Represents fractional ownership in a corporation. Owners of common stock have certain rights, including the right to vote, the right to receive declared dividends, and the right to sell their shares.
Main Reasons for investing
Make a profit from your investments through 1) Dividends or 2) capital increase in the stock value
Risk Reward Potential of Investing
Unlimited upside potential
Can only lose what you invest
Shareholders Rights
1) to receive a stock certificate
2)Inspect certain (income sheet and balance statement) corporate books but not all
3) Receive dividends if they are declared
4) receive a portion of the companies assets if the company is dissolved
5) Vote on board members and important matter
Voting methods
Regular- 1 vote per share per candidate (benefits larger shareholders
Cumulative (block) - 1 vote per share times the number of directors being voted on. Can be distributed in any way the individual wants (benefits minority share holders)
Shareholders do not have the right to…
1) A dividend if one was not declared by the board
2) demand or vote on the dissolution of the company
3) To vote for officers or senior management of the company
Advantages of Common Stock
Best hedge against inflation
Greatest potential for long-term capital appreciation
Negative impact on common stock
Higher taxes
Rising Interest rates
Decrease in GDP
High Unemployment rate
Positive impacts on common stock
Lower taxes
Falling interest rates
Increasing GDP
Low unemployment rate
Authorized Stock
Represents the maximum number of shares a company may legally create for issuance. These terms are included in the Articles of Incorporation.
Issued Stock
Stock taken from the authorized stock and sold to the public
Treasury Stock
Stock that a corporation issued to the public but has repurchased. It is considered issued, but not outstanding. It cannot vote or share in dividends
Reasons Companies buy back stock
1) increase Earnings per share
2) to finance future acquisitions
3) Provide stock for employee stock option plans
4) to fight a takeover attempt
Outstanding Shares
Issued stock-treasury stock = issued stock
votes
receives dividends
are used to calculate Earnings per share
Long Position
You think the price will increase so you buy the stock
Short Position
You think the price will decrease so you borrow the stock, sell it and later repurchase it at a lower rate and return it
Trade Date
The date on which a securities transaction occurs between two parties.
Regular Way Settlement
SEC Rule 15c6-1 provides for regular way settlement on the 2nd business day after trade date for common stocks, corporate bonds, municipal bonds, and most Federal Agency issues.
Regulation T Settlement
Reg T is the regulation of the Board of Governors of the Federal Reserve System that covers customer cash and margin accounts and the extension of credit by broker-dealers.
Blue Chip Stocks
Stock issued by a nationally known company that has a good reputation for quality of management, products, and services. Blue Chip Stocks are expected to pay dividends in good times and in bad times. They will generally maintain about a 50% Dividend Payout Ratio.
Growth Stock
A stock whose earnings are expected to grow faster than the earnings of an average company. A growth stock normally pays very little in dividends (low dividend payout ratio) and earns a high rate of return.
Cyclical Stock
A stock that is susceptible to fluctuation related to various different cycles. The most common cycle would be the business cycle, with the stock increasing in value as the business cycle expands and the stock decreasing in value as the business cycle contracts.
ie. auto manufactures
steel companies
Appliance manufactures
Housing Companies
Paper Company
Tool and die manufacturers
Counter Cyclical Stocks
Stocks that tend to move in the opposite direction of the economy
Gold Mining Companies
Budget Retailers
Temp agency
Defensive (non-cyclical) Stock
A stock that normally declines less than the average security in a market decline. Defensive stocks are not subject to the business cycle to the extent that a capital goods company or cyclical company would be.
ie. public utilities,
food companies,
tobacco companies, and
clothing manufacturers.
Utility Stocks Characteristics
Offer above average dividend yields to investors. Typically over 75% dividend payout
Usually highly leveraged
More susceptible to interest rate changes
Special Situation Stocks
Undervalued and therefore their price can increase suddenly
1) new management
2) introduced new product
3) discovery of natural resources on corporate property
American Depository Receipts
Represents receipts for shares in foreign corporations. By purchasing ADR’s, American investors receive dividends in American dollars through the bank that holds the shares.
No Voting Rights
Dividends are paid in US currency
Are taxed as gains and losses and are reported on form 1099b
Are not callable
Dividends per share formula
Dividends paid to common stock holder / outstanding common shares = DPS (in dollars)
Dividend Payout Ratio
Dividends per share / Earnings per share = DPR (as a percentage)
Retained Earnings Formula
Net income - dividends paid
Price to Earnings (P/E) Ratio
Market price / Earnings per share
Stock Split (or reverse split) formula
Share you have * (first number / last number) = New Amount of Shares
Stock Split (or reverse split) formula for new value
Original value of all stocks / new amount of shares = New value of Stocks
Warrants
A warrant is a long-term option to buy stock at a specified price from the issuing company.
Used as a sweetener, issued at a price higher then the current market value
Debenture
Debt obligation of a corporation backed only by the full faith and credit of the corporation itself and not by any specific asset of the corporation.
Rights (Subscriptive rights or preemptive rights)
Opportunity for current shareholders to purchase newly issued shares at a price lower then the current public offering
Rights generally have a max maturity of 90 days
Preferred Stock
Preferred stock is an equity security. It is preferred because it carries priority claim over common stock when it comes to company assets in the event of bankruptcy/dissolution/insolvency. Types of preferred stock include prior preferred, cumulative preferred, participating preferred, callable preferred, and convertible preferred.
Dividend is fixed
Does not receive preemptive rights or voting privileges
Prefered Stock ‘riders’
Cumulative- all past due dividends must be paid before common stock dividends
Convertible- can convert to regular stock
Participating- can receive more then just the fixed minimum dividend
Callable- the issuer may redeem the stock at a set premium over par at a specific date
Dividends can be…
Cash
Stock of the corporation
Stock of other companies owned by the corporation
Treasury stocks
Products
Short Stocks and dividends
The person who borrows the stock must pay back the dividend, whether cash or stock, to the lender
Dividends are paid
quarterly
Date relating to Dividends
Declaration date
Ex-Dividend Date
Record Date
Payable Date
On the date that a corporation declares a cash dividend it becomes
a current liability on the balance sheet of the corporation
Current Yield of common stock formula
annual dividend / market price = current yield
REITs may invest in…
long term mortgages
Own real estate
Make short-term construction and development loans
Invest in other REITs
Types of REITs
Equity REITs- buy buildings
Mortgage REITs- lend money
Hybrid REITs- do both
IRS REIT rules
Must pay out at least 90% of their income and at least 75% of assets must be in real estate activities
REITs provide
Income
Diversification
Growth
Professional management
Appreciation of property value
Liquidity
Have low Correlation to the stock market
Potential risks with a REIT
decrease or weakening demand for real estate
Increase in interest rates
Overbuilding by property developers
REITS are not…
Redeemable
investment companies
regulated under the investment company act of 1940
direct participation programs or limited partnerships
Typical Dividend Payouts
Blue Chip
Growth
Public Utilities
Blue Chip - around 50%
Growth - < 25%
Public Utilities - > 75%
Price to Earning (P/E) ratio average
The average is 20 to 25 times earnings
Price to earnings ratio AKA
Multiples at which the stock is selling
High, Low and No Price to Earnings
High- Mean higher future growth potential
Low- Either lower growth potential or under valued
No- means the company is losing money
Treasury stock is best defined as
Issued shares - outstanding shares
