Stocks Economics 71a: Spring 2007 Mayo, chapter 10 Lecture notes 4.1.
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Transcript of Stocks Economics 71a: Spring 2007 Mayo, chapter 10 Lecture notes 4.1.
Common Stock
Ownership of piece of a firm Key parts
Voting rights (control) Dividends Right to assets Limited liability
1. Voting and Control
Voting rights In proportion to share holdings Annual meetings Proxy
Firm control Shareholders elect Board of Directors Oversee management Sometimes difficult to remove
Voting Methods
Traditional Everyone votes on each candidate Like regular election
Cumulative One vote per board position
5 members - get 5 votes per share Can cast all votes for one candidate Increases power of minority voting blocks
Can group all votes for one candidate
2. Dividends
Payments to shareholders from firm Usually cash
Usually paid quarterlyFirm sets amountsDividends paid after all other obligations
are metAmount can be zero
Dividend Timing
Declaration date (June 3rd)Ex-dividend date (June 16)Date of record (June 18)Payment date (June 30)Key date: Ex-dividend date
Purchase before: get dividend Purchase after: no dividend
Dividend Decisions
Profits of the firm (earnings) Shareholders (dividends) Retained earnings (investment)
Payout ratio = (dividends)/earningsDividend yield =
(dividends per share)/(price per share)
Does Dividend Policy Matter?
Example: Assets - Liabilities = 100 = Shareholder equity Shares = 100, price per share = 100/100 = 1 Earnings = 10 1. Pay out earnings as dividends 10/100 = 0.1 per
share 2. Hold earnings as cash
Value of the firm goes from 100 to 110 (A-L) Price per share goes to 110/100 = 1.10 Shareholders gain 0.1 per share
Does Dividend Policy Matter?
In theory, No In real life, Yes
Worry about firm investing funds wisely Worry about firm running off with funds Stock may not be priced correctly
Dividend Reinvestment
Firm allows you to buy stock with dividends
No fees or commissionsSometimes below market prices
What is a Stock Return?
Stock held from time t to t+1Pays dividend during this time of d(t+1)
Why is this sensible? Increase of 1 dollar after investment t to
t+1€
Rt+1 =Pt+1 +dt+1 −Pt
Pt
Two Parts to a Stock Return
= (capital gain) + (dividend yield)€
Rt+1 =Pt+1 +dt+1 −Pt
Pt
Rt+1 =Pt+1 −PtPt
+dt+1
Pt
Numerical Example
Price(last year) = 100 (per share)Price(today) = 110Dividend = 3 (per share)
€
Rlastyear =110 + 3 −100
100= 13%
Rlastyear =110 −100
100+
3100
Rlastyear = 10% + 3% = 13%
3. Rights to Assets
Shareholders have rights to residual assets in a bankruptcy case
Value distributed after other obligations met Bills Tax payments Bond holders
Often this can be zero
4. Limited Liability
Liabilities of shareholders are limitedNot responsible for amounts firm owesOr lawsuits against the firmWhat does this mean?
If you buy a stock for $10, the most you can lose is $10
Preferred Stock(Debt like)
Fixed, promised dividend Similar to interest payments on debt Cumulative basis: missed dividends must
be paidNo voting rights (usually)Call option
Firm can buy back
Bankruptcy Priorities
Bills owed and tax paymentsDebt holdersPreferred stock holdersCommon stock holders
Issuing and Increasing Shares
Initial Public Offering (IPO) at start New issues (issue more shares)
“Dilution” Rights offering Stock options
Stock spin-offs Spin off subsidiaries
Stock splits 2 for 1 split
Stock dividends
Stock Splits
Example: 2-1 split Number of shares increases by 2 Price falls by 1/2 Dividend reduced by 1/2
No real impact Why?
Lower price, more investors Reverse split:
1-2 split Increase price, why??
Stock Dividends
Pay dividends with shares of stockSimilar to stock splitNo change for investors
More shares Price goes down
Tax Treatments
Firm Interest payments on debt are tax deductible Dividend payments are not Example
(Profits – debt interest payments) Pay taxes on this amount
This gives a tax advantage to the firm for using debt financing
Tax Treatments
Individual Investors Capital gains (lower rates) Dividends (some at lower rates)
2003 tax law change Before 2003 dividends taxed at higher rates
Long Term Annual Returns (1/28-6/2005)Dividends Reinvested
Raw Returns Inflation Adjusted
Stocks 12.4% 9.2%
Corp Bonds 6.3% 3.2%
Gov’t Bonds 5.8% 2.8%
TBills 3.8% 0.7%