Chapter 8: Common & Preferred Shares Flashcards
what are common shares
- Ownership in a company
- Value of each shares changes with changes in the total value of company’s equity and it’s
total shares outstanding
what do preferred shares provide
- Provides a cash payment / dividend
- These cash payments / dividends are “fixed”; hence preferred shares are often viewed as
fixed income and not equity - Most attractive to an investor wanting a steady income and more security that their
investment will not be volatile
What has the potential for the greatest increase (or decrease) in value – common or preferred shares?
common shares; greater risk, greater reward
what is the potential for common shares
- Potential for significant gains and losses (you can lose it all without any compensation for your total loss)
- since you wont get dividends
what is a stock split
- when a company “splits” their shares by doubling (or tripling or more) its shares outstanding
- it doesn’t increase a company’s market capitalization
what is market capitalization
- total equity value
- total shares outstanding x share price
what does happens to the share price if the stock split is 2 for 1
the share price is halved
how do you calculate a stock split
- # for
- like 2 for 1
- would divide the share price by 2 and multiply by 1
- would multiply share amount by 2 divide by 1
why would a company split its shares if it has no effect on the overall equity value/market capitalization?
- liquidity: makes the stock more affordable for smaller investors, and easier to buy and trade the stocks
- can make it seem more affordable and attractive to investors
what are dividends
cash payments to shareholders
is issuing dividends required
no, they can but they don’t have to
how much of net income do canadian banks typically pay as dividends
40-50% of net income
why would some companies retain all of their net income instead of paying dividends
they may see opportunities to invest their net income in
what is the timing of dividends like (what are the different dates related to dividends)
- declaration date
- purchase date
- ex dividend date
- record date
- payment date
what happens on the purchase date
it is the day the actual stock was purchased
what happens on the ex dividend date
- always happens 1 business day before the record date
- the share price goes down by the dividend paid amount on this date
- need to be a shareholder before this date to get the dividends
when do you have more wealth, buying shares before the ex dividend date or after
- its the same
- if you buy the shares before the ex dividend date, the share price will decrease by the dividend payment amount, which you will receive
- if you buy the shares after the ex divided date, you will be able to buy the shares for a cheaper amount, but you won’t be getting the dividends
what happens to the company value when dividends are paid
- goes down by the amount of dividends paid
- ex. company value = $2M, they pay $0.5M in dividends, the company value becomes $1.5M
what are stock dividends
- when the COMPANY decides to issue a stock dividend instead of a cash dividend
- so you would receive additional company shares (that you would get taxed on)
The share price is $50, the dividend amount is $0.25, and you own 600 shares. if a company is issuing stock dividends, how many stocks would you get
600 (amount you have) x $0.25 (dividend amount) = $150 (dollar amount of dividends you are owed)
$150 (how much you are owed) / $50 (the price of 1 stock) = 3 shares
what are dividend reinvestment plans (DRIPs)
- when the INVESTOR decides to receive a stock dividend instead of cash
- the investor receives more stocks of the company instead of cash
- calculated the same way for stock dividends
what is the tax treatment for capital gains on common shares
- capital gains = increases in share price
- are taxed at 50% of the tax rates on interest or employment income
- ex. your income tax is 30%, then your tax on capital gains is half of that, 15%
- you are only taxed on the capital gains and not the price you paid for the stocks or the market value
what are voting privileges like in common shares
- most times you get to vote
- sometimes there are restricted voting shares that restrict the rights/votes of shareholders
- but there are voting shares
what are multi-voting shares
- shareholder has more rights
- when each share = multiple votes
- ex. 1 share has 10 votes, instead of being 1 share = 1 vote
what are stock quotes
provide different information about stocks on financial publications
what is the tax treatment for dividends of common shares
- dividends receive tax credits
- ## they reduce the amount of tax paid compared to interest or employment income
what are examples of information provided on stock quotes
- high/low; the highest or lowest price during the period stated (can be the highest/lowest of the day, week, month, or 52 week period)
- close; the last trading price of the day
- change; the change from the previous day’s closing price
- volume; the # of shares traded during the period
- dividends; the total dividends per share paid over the past 52 weeks
what are preferred shares
- Ranked behind debt holders in front of common shareholders
Dividend payments are not obligatory (like interest payments) but preferred dividends must be paid before common share dividends can occur - Primarily a fixed income instrument – limited opportunity for price increases vs. common shares
what is the tax treatment for preferred shares
Payments are not tax deductive; investors receive dividend tax credit and, hence, pay less tax rate than if interest received
what are fixed rate (straight) preferreds
- have a stated par value (often $25) and a fixed dividend
- are like every other instrument in finance where the value is the pv of future cash flows
- there is no maturity date
- the dividends are in perpetuity
what is perpetuity
- like indefinite cash flows
- dividends for preferreds are in perpetuity (they always get paid the same amount every year)
what is the formula for perpetuity pricing
PV = C / r
- C = preferred dividend received
- r (in the POV of the investor) = the rate of return required on the preferred
- r (in the POV of the issuer) = cost of funding the preferred
Ex. what is the price of a preferred share with a dividend of $4 and a required rate of return of 10%
PV = C/r
PV = $4 / 10% = $40
Ex. what is the rate of return of a preferred with a price of $30 and a dividend of $2
PV = C/r
r = C/PV
r =$2 / $30 = 6.67%
what is rate of return also known as
market/dividend yield
how do you calculate dividend yield
dividend yield = dividend/price
why is looking at dividend yield important
- allows us to compared dividends more comprehensively
- ex. if you receive a $5 dividend from company A and a $2 dividend from company B, is company A better?
- depends on what you are paying for the stock
- if company A price is $50, and company b price is $10, then comparing their dividend yields, 10% vs 20% respectively, company b is actually better
what is a stock index/average
- used like a dividend yield
- so you can compare the performance of all companies and gauge overall market movements
how are stock indexes calculated
- they are typically value weighted
- each stock in the index is weighted based on its equity value / market capitalization
- so if a company is worth more, it is weighted more in the index
how are stock averages calculated
- add each stock price and divide it by the # of stocks
- if the stock price is higher, it will be worth more
do stock indices or stock averages make more sense and should give a better gauge of market movements
- stock indices
- stock averages don’t accurately gauge market movements
what is the dow jones industrial average (DJIA)
- a large stock average
- Average based 30 stocks that is price weighted (add up the share prices and
divided by 30)
why does the dow jones industrial average get so much attention
- Old habits are difficult to break – it has been used for over 100 years
- The 30 stocks are bellweather stocks for the U.S. economy (American Express, Wal-
Mart, Home Depot) - the Dow Jones company also previously owned the Wall Street Journal which would emphasize DJIA movements
what are major stock indices
- U.S. – S&P 500
- Canada - S&P / TSX Composite
- Japan – Nikkei Stock Average
- United Kingdom - FTSE 100 (pronounced “footsie”)
- Germany – DAX
- France – CAC 40
All are market or value weighted except the Nikkei
