Common Stock Flashcards
1
Q
There are two types of stock; what are they?
A
- Common Stock
2. Preferred Stock
2
Q
What is common stock?
A
Representation of ownership in a company (issuer).
3
Q
Since shares of stock represent overall ownership of a company, what is common stock referred to?
A
Equity position.
4
Q
Define “Issuer”
A
An organization that distributes and sells securities to investors.
5
Q
Define “Security”
A
Legal term for investment.
Ex.: common stocks, bonds, mutual funds, ETFs, options.
6
Q
Equity
A
Formal term for ownership.
7
Q
What are stock prices dictated by?
A
Supply and demand.
8
Q
What are the two general ways to make money on common stock?
A
Capital appreciation or cash dividends.
9
Q
What is capital appreciation?
A
Also known as growth or capital gains, when an investor purchases stock, it is purchased at a specific price. If the company does well and the stock prices increase, you can sell your shares for a gain. This is capital appreciation.
10
Q
What are cash dividends?
A
Represents a profit made by a company and is distributed to shareholders.
11
Q
What are retained earnings?
A
Profits retained by a company that are often used to expand and reinforce business operations.
12
Q
What are “growth companies”?
A
Companies that grow faster than the general economy. Think Amazon. Investments in growth companies provide the opportunity for capital appreciation, but do not pay income (dividends) to shareholders.
13
Q
List seven (7) rights of stockholders:
A
- Right to pro rata share of dividends;
- Right to vote for BOD;
- Right to inspect books and records;
- Right to maintain proportionate ownership;
- Right to vote for stock splits;
- Right to assets upon dissolution;
- Right to transfer ownership;
14
Q
Do stockholders have the right to vote for dividends?
A
No. They have the right to receive their pro-rata share of dividends.
15
Q
What does “pro-rata” refer to in the ownership context?
A
Pro-rata relates to the amount of shares owned. For example, if a stockholder owns 10% of the outstanding shares, they should receive 10% of the dividends paid.
16
Q
Who approves dividend payouts?
A
Only the BOD.
17
Q
Common stocks may pay dividends in three forms. What are they?
A
- Cash
- Stock
- Product
18
Q
When a company makes a profit, what choice do they face in terms of how to use the profit?
A
The company can either retain the profit (retained earnings), pay the profit to their shareholders in the form of a cash dividend, or do a little of both.
19
Q
Which companies are more likely to pay a cash dividend?
A
Companies that are beyond their initial growth phase and don’t need to invest profits to grow their business.
20
Q
How often do companies make cash dividend payments?
A
Generally payments are made quarterly, although this is not required.
21
Q
What is a “stock dividend??
A
A payment of extra shares to stockholders. They are a “re-shuffling” of numbers in order for the company to manipulate its stock price. Each investor will end up with more stock, but each share will drop proportionately in price.
22
Q
Does a stock dividend increase the overall value of a stock position?
A
No.
23
Q
How do you answer a stock dividend question?
I.e., “An investor owns 100 shares of stock at $20/share. The investor receives a 25% stock dividend. What changes?”
A
- Find the stock dividend factor.
- Find the number of shares adjustment.
- Find the price per share adjustment.
- Put it all together and confirm that the investor ends with the same overall value they started with.
24
Q
How do you find the stock dividend factor?
A
To find the stock dividend factor, add the stock dividend percent (in decimal form) to 1.
SD factor = SD (decimal form) + 1
Ex. Stock dividend of 25% equals a SD factor of 1.25.
25
How do you find the number of shares adjustment?
Multiply the original number of shares by the stock split number.
New shares = old shares x SD factor.
26
How do you find the price per share adjustment?
Divide the original price per share by the stock dividend factor.
New price = old price / SD factor
27
An investor owns 300 shares of JPM stock at $115. They receive a 15% stock dividend. What changes?
1. Find the SD:
- SD = 1.15
2. Find the number of shares adjustment:
- 300 shares x 1.15 = 345
3. Find the price per share adjustment:
- $115 / 1.15 = $100 per share
4. Summarize:
- Before split: 300 shares at $115 = $34,500
- After split: 345 shares at $100 = $34,500
28
List three stock dividend consequences.
1. More shares outstanding
2. Lower price per share
3. Same overall value
29
How do stockholders exert influence over the direction of the company they're invested in?
By voting for the Board of Directors.
30
List some of the BOD's powers.
Hiring and/or firing of senior level employees.
Managing senior level employee compensation.
Creating and implementing general company policies.
Approving dividend payouts to investors.
31
Is the BOD responsible for the day to day management of the company?
No.
32
Name the two voting structures for the BOD.
1. Statutory
| 2. Cumulative.
33
How does a statutory voting scheme work?
Allows the stockholder to apply only the amount of votes they have to each BOD position being voted on.
34
How does a cumulative voting scheme work?
Allows the stockholder to apply the total amount of votes they have to any BOD position being voted on.
35
Which voting scheme is better for small stockholders, statutory or cumulative?
Cumulative.
36
Which voting scheme is better for large stockholders, statutory or cumulative?
Statutory.
37
What are the two primary ways a stockholder can vote?
1. At the annual stockholder meeting; or
| 2. Through a proxy.
38
How do publicly traded companies fulfill their shareholders' right to inspect books and records?
By supplying investors with financial disclosures.
39
What are the two most common financial disclosures?
1. 10-K annual report (audited)
| 2. 10-q quarterly report (unaudited)
40
What does it mean for a company to "dilute" your ownership?
Lessen.
41
List two dilutive efforts tested on the SIE exam.
1. Issuance of new shares
| 2. Issuance of convertible securities
42
Define "security"
a formal way of referring to an investment
43
Examples of securities
stocks, bonds, mutual funds, options, ETFs
44
What is the "initial public offering"?
First public sale of their shares.
45
List the four categories of types of shares available
1. Authorized
2. Issued
3. Outstanding
4. Treasury
46
Define "Authorized stock"
the amount of stock that a company is permitted to sell to investors.
47
Define "Issued stock"
Those shares that are sold to investors.
Typically, companies don't sell all of their issued shares up-front.
48
Define "Outstanding stock"
Shares that are owned by the public. After the initial sale of shares, the number of issued shares and outstanding shares is the same.
49
Define "Treasury stock"
Shares repurchased from the market by the company.
50
What is the "pre-emptive right"?
The right buy new shares being offered by a company before they're publicly offered. When the company issues new shares, you have the opportunity to purchase the same percentage of the new shares as what you currently own in order to maintain the same ownership percentage.
51
How do "pre-emptive rights" work?
Investors receive one right for every share of stock owned. Each right will have a specific value (for example, five rights may equal 1 new share).
52
Do rights have intrinsic or extrinsic value?
Intrinsic.
53
What does it mean for a right to have intrinsic value?
Rights have immediate value. For each right that a stockholder has, the shareholder can purchase a new share at reduced cost.
54
Why do rights have intrinsic value?
Because the company saves money by avoiding the services of an underwriter.
55
What services does an underwriter provide?
Underwriters are hired to help organizations market and sell securities to the public.
56
What options do investors have when they receive rights?
1. Investors can exercise them and purchase the new shares at the exercise price.
2. If the investor doesn't want to buy new shares, they may sell the rights in the market.
3. Investors can let the rights expire (typically within 90 days).
57
If a stockholder exercises all their rights, is their ownership diluted?
No.
58
What are warrants?
They are similar to rights as they provide the right to purchase shares from a publicly traded company at a fixed price.
59
What kind of value do warrants have?
Time value, meaning the length of time they exist gives them value. They have an exercise price that's fixed over time. The market price is not. So, over time, warrants add value.
60
How long do warrants last?
Typically, five or more years.
61
Why are warrants considered a "sweetener" during the sale of another security?
Because if a company is having trouble selling a bond, they can make the offering more attractive by attaching a warrant to the bond.
62
True or false, the issuing of a warrant is a dilutive action?
True.
63
Why is a warrant considered a dilutive action?
If a publicly traded company issues warrants, they're giving out new shares, but not to everyone.
64
Does the issuance of warrants require stockholder approval?
Yes.
65
Why are bonds valuable?
They pay interest to their investors.
66
What is a "convertible bond"?
A bond that can be turned into common stock.
67
Why is a "convertible bond" considered a dilutive action?
Because if you choose to convert your bond to common stock, you alone will receive new shares of the company - others will not.
68
Does a company need stockholder approval to issue a convertible security?
Yes.
69
Why would a company want to issue convertible securities?
Because a company can offer them with lower payment rates due to the fact that they're being offered with an extra benefit (the conversion feature). The less the company pays on their bonds or preferred stock, the more earnings they keep.
70
Name the two types of stock splits.
1. Forward stock split
| 2. Reverse stock split
71
What do forward stock splits do?
Increase the number of outstanding shares (and decreasing share price).
72
What do reverse stock splits do?
Decrease the number of outstanding shares (and increasing share price).
73
Why would a company consider a stock split?
If it feels that its stock price is too expensive or too cheap.
74
When should a company pursue a forward stock split?
When the company feels its stock price is too expensive for the average investor.
75
List the steps to follow in answering a stock split question -- i.e., A stockholder owns 100 shares of ABC Company at a current market price of $150 per share. How will a 2:1 forward stock split impact shareholders?
1. Find the stock split factor.
2. Find number of shares adjustment.
3. Find the price per share adjustment.
4. Combine and compare. Total should be same.
76
How do you find the stock split factor? Ex. 2:1
SS factor = first SS number/second SS number
- 2/1 = 2
77
How do you find the number of shares adjustment? Ex. 100 shares at 2:1 forward stock split.
New shares = old shares x SS factor
New shares = 100 x 2
New shares = 200
78
How do you find the price per share adjustment? Ex. 100 shares at 2:1 forward split with current price of $150 per share.
New price = old price/SS factor
New price = $150/2
New price = $75
79
Summarize: A stockholder owns 100 shares of ABC Company at a current market price of $150 per share. How will a 2:1 forward stock split impact shareholders?
Before split:
- 100 shares @ $150 = $15,000
After split:
- 200 shares @ $75 = $15,000
80
Simple summary: A stockholder owns 100 shares of ABC Company at a current market price of $150 per share. How will a 2:1 forward stock split impact shareholders?
100 shares of ABC @ $150
(100x2) shares of ABC @ ($150/2)
200 shares of ABC @ $75
81
When is a reverse stock split pursued?
When a company feels their stock price is too low.
82
What is a liquidation?
The sale of company assets.
83
List the order of payout during a company's liquidation.
1. Unpaid wages
2. Unpaid taxes
3. Secured creditors
4. Unsecured creditors
5. Junior unsecured creditors
6. Preferred stockholders
7. Common stockholders
84
What is a "lien"?
The right to property if a loan cannot be repaid.
85
What does it mean to "liquidate" an asset?
To turn an asset into cash; to cash in an investment.
86
What does a "transfer agent" do?
- Transfer ownership from sellers to buyers after trade occurs;
- Maintain book of stockholders;
- Make dividend payments to stockholders;
- Distribute proxies (voting materials) to stockholders;
- Keep accurate count of shares outstanding.
87
Is common stock "negotiable"?
Yes.
88
What does "negotiable" mean?
It can be bought and sold among investors who are "negotiating" prices.
89
What is the "secondary market"?
Where stocks trade after the initial public offering (IPO). Commonly referred to as the "stock market."
90
If a security is not negotiable, it's _______.
Redeemable.
91
What is a redeemable security?
One that is purchased directly from the issuer, not from another investor in the market.
92
Define "Issuer"
The organization responsible for creating, registering, and selling a security.
93
What is the one reason a company sells its stock in an IPO?
To raise money.
94
What is a "primary distribution"?
Where the sale of securities occurs and the proceeds goes to the issuer. An IPO is a type of primary distribution.
95
When does a "secondary distribution" occur?
When stock is being sold to the public, but the shares have been previously owned by a party other than the issuer.
96
The secondary market is divided into four subsections:
1. First market
2. Second market
3. Third market
4. Fourth market
97
What trades on the first market?
Listed stocks trading on exchanges.
98
Define "listed"
When a stock is capable of being traded on a stock exchange.
99
Define "stock exchange"
A specific place where stocks trade.
100
Define "over-the-counter" (OTC) trade
When a trade of a security takes place between two parties, but not on an exchange.
101
What is the third market?
Where listed stocks trade OTC.
102
What is the second market?
Where unlisted stocks trade OTC.
103
What is the fourth market?
Where large institutions trade without brokers. Operates through Electronic Communications Networks (ECNs).
104
What does a "transfer agent" do?
Change ownership of the stock from the seller to the buyer.
105
What does a "clearing agent" do?
Finalizes the trade. They are responsible for ensuring the buyer and seller fulfill their ends of the trade.
106
What are the two types of settlement?
1. Regular-way
| 2. Cash settlement
107
When does a "regular-way" settlement occur?
Two business days after trade (T+2).
108
When does a "cash settlement" occur?
Same day if executed by 2:30 pm EST.
109
What does it mean to sell short?
To sell borrowed securities in the hopes of buying them again at a lower price, thereby making a profit.
110
What are dividends?
Earnings passed on to stockholders.
111
Are companies required to pay dividends?
No.
112
Who determines if a dividend will be paid?
A company's BOD.
113
What are the three important dates to remember in the dividend context?
1. Declaration date
2. Record date
3. Ex-dividend date
4. Payable date
114
What is the Declaration date?
The day the BOD publicly declares the dividend.
115
What is the record date?
The day a stockholder must be "on the books." An investor must be a settled owner of the stock on the record date in order to receive a dividend. Remember that a stock has a two business day settlement time frame.
116
What is the ex-dividend date?
The first day the stock trades without the dividend. Meaning, if you bought the stock on the ex-date, you would not receive the dividend.
117
When is the ex-dividend date for a cash settlement transaction?
The business day after the record date.
118
What is the payable date?
When the dividend payment is made to the stockholders.
119
Order of dividend dates:
DERP
Declaration Date
Ex-Dividend Date
Record Date
Payable Date
120
Ex-Dividend Date for stock splits
The day after the payable date.
121
What is an ADR?
American Depository Receipts
122
Key points for ADRs
- US-registered receipts for foreign investments
- Created by domestic financial firms with foreign branches
- Trade in US dollars in US markets
- Subject to currency exchange risk
- No voting or preemptive rights
- Foreign government tax withholding creates a US tax credit
123
What does an investor or group of investors do when they want to obtain a significant portion of an issuer's stock?
Extend a tender offer to current shareholders.
124
What are tender offers?
Proposals to purchase stock from current investors, often at premium prices.
125
Define "Long"
The purchase and subsequent ownership of a security.
126
Define "Short"
The sale of borrowed securities.
127
How many days must an investor be provided to make a decision when faced with a tender offer?
20 business days. If any aspect of the tender offer changes, the offer must be extended by another 10 business days.
128
What does "suitability" refer to?
The risks and benefits of an investment; used to determine if an investment is "suitable" for an investor.
129
Define "hedge"
protection from risk.
130
Key points for common stock suitability
Comes with considerable market risk
Generally suitable for younger investors
Hedge against inflation
131
What is a "systematic risk"?
When an event or circumstance negatively affects the overall market.
132
What is a "market risk"?
A specific type of systematic risk that occurs when an investment falls in value due to a market or economic circumstance.
133
Does diversification reduce systematic risk?
No.
134
What is "inflation risk"?
Also known as purchasing power risk; general prices rise more than expected; common stock tends to outpace inflation over long-term periods.
135
What are the two major types of systematic risks to be aware of?
Market risk and inflation risk.
136
What is company size measured by?
Market capitalization.
137
How do you find market capitalization?
Multiply the stock's market price by the number of shares outstanding.
MC = shares outstanding x market price.
138
Large-cap:
More than $10B
139
Mid-cap:
$2B to $10B
140
Small-cap:
$300M to $2B
141
Micro-cap:
$50M to $300M
142
Nan-cap:
Less than $50M
143
What is "business risk"?
Products or services in low demand due to competition or mismanagement.
144
What is "financial risk"?
High debt levels negatively affect company performance.
145
What is "regulatory risk"?
Potential or current government regulation negatively affects an investment.
146
What is a "liquidity risk"?
Also known as marketability risk; inability to sell a security without dropping price dramatically.
147
What is a non-systematic risk?
Affects specific investment or sector; can be reduced by diversification.
148
What is "net worth"?
All the things you own (assets) minus your debts (liabilities).
Net worth = assets - liabilities
149
What does the "current ratio" involve?
Current assets and current liabilities, both of which are short term.
150
Why use the "current ratio"?
By focusing on short term finances, investors can use the current ratio to determine short term cash levels and ability to pay short term obligations.
151
Define "current asset"
Assets able to be converted into cash within one year.
152
Examples of current assets:
cash, accounts receivable (money owed to the company), and inventory.
153
Define "current liability"
Liabilities owed now or will be within one year.
154
Examples of current liabilities:
taxes, accounts payable (money owed by the company), and payroll expenses.
155
Formula for determining the Current Ratio:
CR = current assets/current liabilities
*More than 1 = good; less than 1 = bad.
156
What is "Net Working Capital"?
Determines liquid cash and marketable assets on hand.
157
Formula for determining Net Working Capital:
NWC = current assets - current liabilities
*positive = good
158
Quick Assets formula
QA = current assets - inventory
*focus is on cash and marketable assets (other than inventory); This is like looking into the wallet of a company.
159
Quick Ratio formula
QR = (current assets - inventory) / current liabilities
*the higher the ratio, the more liquid the company's finances are. If the ratio is over 1, the company has enough short term assets without including inventory to pay off short term liabilities. If lower than 1, the company may sell some of their inventory to pay short term obligations.
160
What is the QR also referred to as?
The acid test ratio.
161
What are Price to Earnings (PE) ratios used for?
To determine if a company is overvalued or undervalued.
162
What is the PE Ratio formula?
PE ratio = market price/earnings per share
*the higher the PE ratio, the more likely that an investment is overvalued.
163
What is the typical range of PE Ratios?
15-25
164
Growth companies typically have _____ PE ratios.
Higher.
165
Value companies typically have _____ PE ratios.
Lower.
166
What does the "Debt Service Coverage Ratio" determine?
Whether a company's revenues can cover their obligations.
167
What is the Debt Service Coverage Ratio formula?
DSCR = net operating income / debt service requirements
168
Net operating income =
gross income minus expenses and taxes
169
Debt service requirements =
the amount of money a company must pay on outstanding loans.
170
It's best to have a DSCR comfortably above ___, as this demonstrates more revenues received than payouts made.
1.
