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Dividends

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  • 1. Personal Finance: An Integrated Planning Approach Winger & Frasca Chapter 11 Common Stock
  • 2. Major Topics
    • Characteristics of Common Stock
    • Fundamental Analysis of Common Stocks
    • Technical Analysis
  • 3. Characteristics of Common Stock
    • Shareholders’ Rights
    • Distributions to Shareholders
    • Opportunities in Common Stocks
    • How to Read Stock Quotations
  • 4. Shareholders’ Rights
    • Right to Vote--Usually, One Share Earns One Vote
    • Preemptive Right
      • Allows Shareholders to Maintain Their Proportionate Ownership Share in the Corporation
    • Right to Share in Earnings or Asset Distributions
  • 5. Shareholders Come Last
    • Shareholders Have a Residual Claim on Assets, Which Means All Other Claims Must Be Paid Before Shareholders Can Receive Any Distribution
    • However, Other Claims Are Fixed:
      • So, if the Company Has Good Earnings, Shareholders Benefit Considerably
      • But Poor Earnings Can Be Damaging
  • 6. An Example of Earnings Distribution
    • Poor Earnings of only $9,000
      • Interest to bondholders $5,000
      • Dividends to preferred shareholders 3,000
      • The balance to common shareholders 1,000
    • Good Earnings of $20,000
      • Interest to bondholders $5,000
      • Dividends to preferred shareholders 3,000
      • The balance to common shareholders 12,000
  • 7. Distributions to Common Shareholders
    • Cash Distributions
      • Regular (Quarterly) Dividend
      • Periodic Share Repurchases
    • Non-cash Distributions
      • Stock Dividend
      • Stock Split
  • 8. Stock Dividends and Splits
    • Although Favored by Some Shareholders, Stock Dividends and Splits Do Not Increase Shareholder Wealth
    • They Simply Provide Shareholders with a Greater Number of Shares, But:
    • The Prices of Shares Fall so that the Total Market Value Remains the Same
  • 9. Opportunities in Common Stocks
    • Growth Companies: Earnings Are Expected to Grow Substantially
    • Income Stocks: Provide a Good Dividend Return
    • Blue Chips: High Quality Stocks
    • Cyclical Stocks: Very Responsive to Changes in the Economy
    • Special Situations: eg., a Takeover
  • 10. Example of a Stock Quotation
    • High Low Stock Div Yld P-E
    • % Ratio
    • 40 30 ABC .40 1.0 17
    • Sales High Low Close Net
    • 100s Chg
    • 243 41 39 40 +3/4
    Quote Continued
  • 11. Fundamental Analysis of Common Stocks
    • Applications of the CAPM
    • Price-to-Earnings Analysis
    • Fundamental Value and Book Value
  • 12. Determining Expected Return
    • A Stocks Expected Total Return (TR) Consists of:
      • Expected Current Return (CR) and
      • Expected Future Return (FR)
    • Current Return is the Expected Dividend Yield for the Upcoming Year
    • Future Return is the Expected Annual Growth in Dividends in the Future
  • 13. Calculating Expected Return
    • Data for ABC Company:
      • Current Stock Price = $20/share
      • Expected Dividend Next Year = $1.20
      • Current Return (CR) = ($1.20/$20) = .06
      • Expected Annual Growth in Dividends in the Foreseeable Future (FR)= 0.08
    • Total Return = Current Return + Future Return
    • TR = CR + FR
    • TR = 0.06 + 0.08 = 0.14, or 14.0%
  • 14. Review of CAPM Approach
    • The Method Provides a Pertinent View of a Company’s Risk--its Beta Value
    • It Brings a Company’s Risk Into the Picture Through the Required Return Equation, Which Expresses How Much Return You Should Earn on the Stock
    • Comparing This Return to What You Expect the Company to Earn Provides a Clear Decision Signal--the Alpha Value
  • 15. Fig. 11.5 Comparing Mead’s required rate of return with its expected rate of return, 1998 Required Rate of Return Expected Rate of Return
  • 16. Fig. 11.5 Comparing Mead’s required rate of return with its expected rate of return, 1998 Required rate of return Expected rate of return = 12.9% = 11.5% Alpha = - 1.1% Sell
  • 17. Price-To-Earnings Analysis
    • A Stock’s P/E Ratio is the Ratio of a Stock’s Price (P) to Its Expected Future Earnings Per Share (EPS)
    • P/E = P/EPS
    • If P = $50.00 and EPS = $2.50, then
    • P/E = $50.00/$2.50 = 20.0
    • Investors Pay $20 for Each $1.00 of the Company’s Earnings
  • 18. Finding P/E Ratios
    • Three Methods
      • Use the Current P/E Ratio
      • Use the Average of P/E Ratios Over Previous Time Periods
      • Use the Company’s Expected Dividend Growth Rate (Ignore % Sign)
    • The Three Methods Can Lead to Quite Different Values
  • 19. Using Book Value
    • A Company’s Book Value is Simply Its Net Worth (Assets minus Liabilities) Divided by the # of Shares Outstanding
    • Book Value May Not Provide A Realistic Estimate of True Value Because:
      • Assets May Have Replacement Costs Much Higher then Book Value
      • Some Assets May Not Appear on the Company’s Books: eg., The Coca Cola Trademark
  • 20. The Market-to-Book Ratio
    • Despite Book Value’s Limitations, Some Analysts Use the Market-to-Book Ratio
    • This Ratio Divides the Stock’s Price by its Book Value. Example: if Price is $40/Share and Book Value is $10/Share, Market-to-Book = 4.0
    • All Other Things Equal, Analysts Prefer Low Values for this Ratio
  • 21. The PEG Ratio
    • Shows the Relationship between the PE Ratio and the Long-Term Growth Rate
      • PEG = (P/E)/Growth
    • All Things Equal, Low Numbers Are Desirable--You’re Buying Growth at a Low Price
  • 22. Technical Analysis
    • A Method of Evaluating Stocks that Does Not Review Underlying Fundamentals, Such as Earnings or Dividends
    • Two Primary Approaches:
      • Pressure Indicators (Compares Two Values in a Ratio Format)
      • Graphic Analysis
  • 23. Pressure Indicators
    • The Advance Decline Line
      • The Number of Stocks Increasing in Price Relative to the Number Decreasing
    • Relative Strength Line
      • The Price Movements of Two Variables, such as One Price Index Versus Another
    • New Highs-New Lows
      • The Number of Stocks Recording their Highest Prices of the Past Year Versus the Number Recording Their Lowest Prices
  • 24. A Time Graph Support Line Resistance Line 1999 2000 Break Out Price Volume
  • 25. Point-and-Figure Graph x x x o o o x x x x o o x x x x o o o o x x x x x x P r i c e x’s record price increases; o’s record price decreases; only price changes greater than a pre-set amount are recorded Time
  • 26. Calculating a 3-Day Moving Average
    • Day Price Calculation Mov. Avg.
    • _________________________________
    • 1 $10 -
    • 2 12 -
    • 3 16 (16+12+10)/3 = 12.67
    • 4 14 (14+16+12)/3 = 14.00
    • 5 13 (13+14+16)/3 = 14.33
    • 6 9 ( 9 +13+14)/3 = 12.00
  • 27. How Useful Is Technical Analysis?
    • Unfortunately, Technical Indicators Often Do Not Lead Stock Prices
    • Following Technical Indicators
      • Often Leads to Excessive Trading and Commissions Erode Any Slight Advantage the Method Might Offer
      • Puts the Wrong Emphasis on Investing by Focusing on Short-Term Trading Instead of Long-Term Investing
  • 28. Next Chapter 12 Fixed-Income Securities