Common Stock: Characteristics, Valuation, and Issuance 7 Common Stock: Characteristics, Valuation, and Issuance

Introduction This chapter describes the characteristics of common stock. It discusses the process for selling securities and the role of the investment banker. It develops the valuation models for common stock.

Common Stock Common stock (C/S) is the permanent long-term financing of a firm. Represents the true residual ownership of a firm Stockholders elect the board of directors.

Balance Sheet Accounts Associated With C/S Par value of C/S Contributed capital in excess of par Additional paid in capital Capital surplus Retained earnings (R/E) Book value per share equity # shares outstanding =

Rights of Common Stockholders Dividend rights Asset rights Preemptive rights Voting rights

Voting for the Board of Directors Majority voting requires more than 50 percent of the votes to elect a director. Cumulative voting Shareholders may concentrate votes on a few candidates. Proxy signing over your voting rights to someone else

Features of C/S C/S classes Stock dividends Stock repurchases Voting and nonvoting Specific ownership Stock dividends Transfer from R/E account to the C/S and additional paid-in capital accounts Stock repurchases Disposition of excess cash Financial restructuring Future corporate needs Reduction of takeover risk Stock splits Reverse stock splits

C/S Advantages and Disadvantages Flexible Reduced financial leverage Lower cost of capital Disadvantages Diluted EPS Expensive

Investment Banking Long-range financial planning Timing of security issues Purchase of securities Marketing of securities Arrangement of private loans and leases Negotiation of mergers

How Are Securities Sold? Public cash offering Selling securities through investment bankers to the public IPO’s Web site: http://www.ipo.com/ Private or direct placement Placing a security issue with one or more large investors Rights offering Selling C/S to existing stockholders Standby underwriting Investment banker purchases shares not sold to rights holder.

Other Issuance Costs Management time Underpricing new equity Stock price declines Incentives “Green shoe” option

Registration Requirements SEC act of 1933 & SEC exchange act of 1934 Any interstate security issue over $1.5 million and having a maturity greater than 270 days is required to register issue with the SEC. Provide all buyers of the new security with a final copy of the prospectus Shelf registration Check NYSE regulations http://www.nyse.com/about/about.html

Global Equity Markets Multinational firms can take advantage of institutional differences from one country to another. Stock markets in United States, Japan, London, and Paris Nearly 24-hour per day trading of C/S Provide investors with opportunities to buy and sell shares any time they wish Global name and product recognition

Valuation of C/S Capitalized value of the stock’s expected stream of cash flow during holding period Uncertain Dividends Not constant Expected to grow over time Capital gain or loss

Dividend Valuation Models Zero growth g = 0 Constant growth dividend ke > g Dt = D0 (1 + g)t Above-normal growth Multiple growth rates

Zero Growth

Constant Growth

Above-Normal Growth 1. Find the PV of the dividends during the above-normal growth period (if two or more above-normal growth periods continue with the PV of the second) 2a. Find the value of the C/S at the end of the above-normal growth period 2b. Discount the answer in 2a to the present time 3. Sum steps 1 and 2b to find p0

Sources of Analyst Growth Rate Forecasts Value Line Investment Survey http://www.valueline.com/ Institutional Brokers Estimate System http://www.ibes.com/ Zacks Earnings Estimates http://www.zacks.com/

Valuing Small Firms Nature of business History of business Economic outlook Dividend paying capacity Industry Earnings capacity Book value Financial condition Majority or minority interest Voting or nonvoting Valuation Web site: http://www.bearval.com/