2What is Stock?Stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing.
3Debt Equity Requires regular interest payments. Must be repaid or refinanced. Company must generate cash flow to payInterest payments are tax deductible.Debt has little or no impact on control of the company.No payment requirements. May receive dividends, but only out of retained earningsEquity providers are aggressive. They can accept downside risks because they fully share the upside as well.Dividend payments are not tax deductible.Equity requires shared control of the company and may impose restrictions
4Types of StocksThere are many different types of stocks which can be invested in based upon your financial position, your risk comfort level, and your investment goals. The basic two types of stock are common stock and preferred stock.
5Common StockCommon stock is the most typical type of stock. In fact, the greatest number of stock issued is in this form. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investing persons or firms get one vote per stock share to elect the board members, who oversee the major decisions made by management.
6Preferred StockSame as with common stock, preferred stock represents some degree of ownership in a company but typically doesn't come with the same voting rights. With preferred stock investors are usually guaranteed a fixed dividend forever. This is different than common stock, which has variable dividends that are affected by the market and never guaranteed.
7Investment BankInvestment banks are organizations through which companies can raise funds by selling stakes (stock) of the company in exchange for cash. In simpler terms, investment banks 'take companies public' by acting as middlemen; the investment bank provides cash from investors for the company, and in return provides new shares of that company to those investors.
8Investment Bank’s Role in Equity Offerings SERVICES:Investment banks provide four primary types of services. Services. Smaller investment banks may specialize in two or three of these categories :RAISING FUNDSADVISING IN MERGERSEXECUTING SECURITIES TRADINGGENERAL ADVISORY SERVICES
9INVESTMENT BANK SERVICES AND COST With most fund-raising efforts, whether they be through debt or equity the investment bank keeps for themselves a nominal percentage of the funds raised in the underwriting process. The amount of money retained as the underwriting fee can range anywhere from 3% to 20% (or more) depending on the risk or difficulty of the fund-raising process.
10SECONDARY MARKETThe secondary market is trading in securities after the initial issue the sale of securities from one investor to other. Unlike the primary market, in secondary market investor can buy a security directly from another investor without the need of any issuing corporation.
11NYSEThe most important secondary markets are securities exchanges, such as stock exchanges. NYSE is the largest exchange in the world with almost 360 billion shares listed. The NYSE is the first type of exchange where much of the trading is done face-to-face on a trading floor.
12NASDAQ The second type of exchange is the virtual sort called an over-the-counter (OTC) market, of which the NASDAQ is the most popular. These markets have no central location or floor brokers whatsoever. Trading is done through a computer and telecommunications network of dealers. It used to be that the largest companies were listed only on the NYSE while all other second tier stocks traded on the other exchanges
14DefinitionIt is a part of equity that is expected to pay a fixed annual dividend to investor.
15Characteristics of Preferred Stock Preferred stocks represent partial ownership in a companyA preferred stock pays a fixed dividend that does not fluctuatePreferred shareholders always receive their dividends first and, in the event the company goes ruined, preferred shareholders are paid off before common stockholdersPreferred stock shareholders do not enjoy any of the voting rights
16Types Of Preferred Stock Cumulative and non-cumulative preferred stockConvertible preferred stockParticipating preferred stockRedeemable preferred stock
17Difference Between Preferred & Common Stock Preferred stock don’t have voting right while common stockholders do havePreferred stock is a stable investment.Common stock holder can seek the benefit of higher dividendPreference over the common stock in case of liquidation or payment of dividend
18Difference Between Preferred Stock & Bond They are junior to the company’s debt obligationsUnlike debt instruments, the company isn’t legally obligated to make dividend payments to its preferred stockholdersDividends don’t accrue between dividend payment dates.
19Factors Effecting Market Price of PS DIVIDENDRISKINTEREST RATE
20Valuation of Preferred Stock It is calculated by the formula;PS = D/rPs = market price of the preferred stockD = next period`s dividend paymentr = discount rate
21DividendsA taxable payment declared by a company's board of directors and given to its shareholders out of the company's current or retained earnings
22Characteristics of Dividends Dividends are not liabilityDividend and taxesFirm cant go bankrupt
24Common StockA share of common stock represents an ownership position in the firm. Typically, the owners are entitled to vote on important matters regarding the firm, to vote on the membership of the board of directors, and (often) to receive dividends.In the event of liquidation of the firm, the common shareholders will receive a share of the assets remaining after the creditors (including employees) and preferred stockholders have been paid off. If the liquidation is bankruptcy related, the common shareholders typically receive nothing, though it is possible that they may receive some small amount.
25Common Stock Valuation As with any other security, the first step in valuing common stocks is to determine the expected future cash flows.Finding the present values of these cash flows and adding them together will give us the value:
26For a stock, there are two cash flows: Future dividend payments The future selling price
27ExampleAssume that you are considering the purchase of a stock which will pay dividends of $2 (D1) next year, and $2.16 (D2) the following year. After receiving the second dividend, you plan on selling the stock for $ What is the intrinsic value of this stock if your required return is 15%?2.002.1633.33?
28Some Notes In valuing the common stock, we have made two assumptions: We know the dividends that will be paid in the future.We know how much you will be able to sell the stock for in the future.Both of these assumptions are unrealistic, especially knowledge of the future selling price.Furthermore, suppose that you intend on holding on to the stock for twenty years, the calculations would be very tedious!
29Some AssumptionsWe cannot value common stock without making some simplifying assumptions. These assumptions will define the path of the future cash flows so that we can derive a present value formula to value the cash flows.If we make the following assumptions, we can derive a simple model for common stock valuation:Your holding period is infinite (i.e., you will never sell the stock so you don’t have to worry about forecasting a future selling price).The dividends will grow at a constant rate forever.Note that the second assumption allows us to predict every future dividend, as long as we know the most recent dividend and the growth rate.
30The Dividend Discount Model With these assumptions, we can derive a model that is variously known as the Dividend Discount Model, the Constant Growth Model, or the Gordon Model:
32Estimating The DDM Inputs The DDM requires us to estimate the dividend growth rate and the required rate of return.The dividend growth rate can be estimated in three ways:Use the historical growth rate and assume it will continueUse the equation: g = brGenerate your own forecast with whatever method seems appropriateThe required return is often estimated by using the CAPM: ki = krf + bi(km – krf) or some other asset pricing model.
33Formulas To Be Used in Numerical Value of Preferred stockDividend per year Ps = DpRate of return keValue Common stock = p₀= D1+ D D3+……...D5(1+i) (1+i)2 (1+i) (1+i)5orP◦= D1+P1(1+r)1
34Formulas To Be Used in Numerical Dividend discount models= D1+ D2+ D3+……………….+D◦(1+g)∞(1+i) (1+i)2(1+i) (1+Ke)∞Assumptions1) When dividend increase at zero rate…..Growth rate is zeroD = D₁I KeWhen dividend increase with a constant rate the formula used to calculate the intrinsic value of common stock is:V= D₁/(ke-g)
35Question NO.1Wayne’s Steak ,Inc. has a 9 %,non-callable,$100 par value preferred stock issue outstanding. On January 1 the market price per share is $73 .Dividends are paid annually on Dec 31. If you require a 12% annual return on this investment, what is this stock intrinsic value to you on Jan,1?
36Question NO.2Delphi products corporation currently pays a dividend of $2 per share, and this dividend is expected to grow at a 15% annual rate of three years, and then at a 10 % rate of the next 3 years, after which is expected to grow at 5% rate forever. What value you would place on the stock if an 18 % rate of return required?
37Question NO.3XYZ company currently paid a dividend of Rs.5.5 per share. This dividend is expected to grow at 15% for the first 4 years ,13% for next 3 years,7% forever. The rate of return currently prevailing in the market is 10% .Calculate the value of common stock.