Goals. Stocks. Common Stock. 1. Voting and Control. Stock basics Historical stock performance

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1 Goals Stocks Stock basics Historical stock performance 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 1

2 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 quarterly Firm sets amounts Dividends paid after all other obligations are met Amount 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)/earnings Dividend yield = (dividends per share)/(price per share) 2

3 Does Dividend Policy Matter? Example: Assets - Liabilities = 100 = Shareholder equity Shares = 100, price per share = 100/100 = 1 Earnings = 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 commissions Sometimes below market prices What is a Stock Return? Stock held from time t to t+1 Pays dividend during this time of d(t+1) R t +1 = P t +1 + d t +1! P t P t Why is this sensible? Increase of 1 dollar after investment t to t+1 3

4 Two Parts to a Stock Return R t +1 = P t +1 + d t +1! P t P t R t +1 = P t +1! P t P t + d t +1 P t = (capital gain) + (dividend yield) Numerical Example Price(last year) = 100 (per share) Price(today) = 110 Dividend = 3 (per share) !100 R lastyear = = 13% !100 R lastyear = R lastyear = 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 limited Not responsible for amounts firm owes Or lawsuits against the firm What does this mean? If you buy a stock for $10, the most you can lose is $10 4

5 Preferred Stock (Debt like) Fixed, promised dividend Similar to interest payments on debt Cumulative basis: missed dividends must be paid No voting rights (usually) Call option Firm can buy back Bankruptcy Priorities Bills owed and tax payments Debt holders Preferred stock holders Common 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 Example: 2-1 split Stock Splits 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?? 5

6 Reducing Shares Buy back shares (share repurchase) Treasury stock Reverse dilution Stock Dividends Pay dividends with shares of stock Similar to stock split No 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 6

7 Goals Stock basics Historical stock performance Goals Stock basics Historical stock performance Real Portfolio Values (Inflation Adjusted, dividends reinvested) Total Portfolios (log scale) 7

8 Dividend Comparison Real Portfolio Values (Inflation Adjusted) Real Portfolio Values (Inflation Adjusted) Real Portfolio Values (Inflation Adjusted) 8

9 Long Term Annual Returns (1/28-6/2005) Dividends Reinvested Goals Stocks Raw Returns 12.4% Inflation Adjusted 9.2% Stock basics Historical stock performance Corp Bonds 6.3% 3.2% Gov t Bonds 5.8% 2.8% TBills 3.8% 0.7% 9

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