Companies Raise money by issuing debt or equity securities or in
combination .Capital Structure refers to composition of debt and
equity capital .
A mix of a company's long-term debt, specific short-term debt,
common equity and preferred equity. The capital structure is how a
firm finances its overall operations and growth by using different
sources of funds.
Debt comes in the form of bond issues or long-term notes payable,
while equity is classified as common stock, preferred stock or retained
earnings. Short-term debt such as working capital requirements is also
considered to be part of the capital structure.
A company has total capital of 10000 cr out of which
4000 cr is debt and 6000cr is equity , so capital
structure of 40% debt and 60 % equity .
It is called a leverage(or levered) company as debt is
part of the capital . 100% equity capital company is
called unleveraged (or unlevered) company .
Types of Shares
Two main type of equity shares are
Common shares or ordinary shares
A common share indicates the ownership of the company The majority
of stocks sold are common stocks. Common stock offers the potential
for growth through rising share prices and increasing dividends.
It is called preferred as owners of preferred stock get dividends before
common stock holders. Preferred stock offers regular income through
fixed dividends and the potential for growth through rising share
prices. The prices of preferred stock tend to be more stable than the
prices of common stock. Preferred stock may offer features such as the
right to redeem your shares at certain times or to convert your shares to
common shares at a certain price — known as convertible preferred
shares. However, preferred stock doesn’t normally come with voting
Types of shares
Common Shares Preferred Shares
Common shareholders are generally entitled
dividend payments – but there’s no
guarantee you’ll receive dividends, and no
guaranteed amount if you do.
vote at shareholders meetings –
shareholders typically get 1 vote per share,
and can vote to elect company directors and
on other corporate matters at the annual
shareholder meeting, or by completing a
shareholder ballot online or by mail. You
have the right to vote because you're taking
a greater risk with common shares.
claim on the company’s assets – if the
company goes bankrupt and is liquidated.
But common shareholders get paid last —
behind tax authorities, employees, creditors
and preferred shareholders.
Preferred shareholders are generally
fixed dividend payments – that
usually don't change, whether or
not the company does well. Dividends
are paid to preferred shareholders
before any dividends are paid to
common shareholders. If the company
can't pay the dividend on preferred
shares in a year, it may carry it forward
and pay it in future years.
claim on company assets – preferred
shareholders have priority over
common shareholders if the company
goes bankrupt and is liquidated.
Common Stock vs Preferred Stock
Infinite life – No maturity
Usually not issued on par
May or May not
At par value with dividend
Cash flow and voting rights
Hybrid between stock and debt
Common shares are issued by pvt ltd or public limited
companies which are listed on exchanges and liquid .
Can issue one class or different classes of shares like
class A or Class B
Companies can issue more than single issue like series A ,
series B , they carry there own stated dividend and may
differ in features like
Fixed annual dividend
Option to convert the preferred stock in to specified
number of common shares
Redemption ( issuing company can buy back as per pre
defined terms )
Can be Cumulative : to pay any missed dividend
Non cumulative: not require to pay missed dividends for
prior years before paying dividend to common share
Priority of claim: in the event of company is liquidity
assets are distributed according to priority of claim.
Debt is liability of the company . Debt investors have
higher claim on companies assets than equity
After the claim of Debt investors it is preferred share
holders who are in line to receive what they are due
Common share holders are last in the line and are
residual claimants in the company.
Valuation of Equity Shares
Three Important types
Discounted Cash Flow analysis
Asset Based Valuation
Valuation of Equity Shares
Discounted Cash Flow
It is based on Time Value of Money concept.
It is estimation of PV of future cash flows from the
Dividends are regular cash flows other version id
dividend cash flow analysis.
Some of the actions which effect number of common shares out
Selling Shares to public for first time is called Initial
Subsequent offers are called secondary equity offering
Buying back shares from existing share holders by
company is called as Share buy back or share
Stock split or stock dividend – issuing one share for
every 2 shares owned
Issuing new stock after warrants
New company creation from existing – Spin off
On issuance of new shares to public , the share holder
of the pvt company will dilute owners percentage
holding and also the EPS dilation .
As his number of shares remain same but total out
standing shares increase
If existing share holder does not buy shares , his
ownership percentage comes down
Same holds for secondary issues .
Some times rights are given to shareholders to buy new
Companies may opt to repurchase directly from exchange
or give offer to existing share holders.
Instead of dividend they may offer the buy back .
This effectively reduces the total shares out standing
This increases EPS .
Stock Splits – Stock Dividend
Number of out standing shares increases proportionally based on
Cum Dividend Ex dividend
Cum-dividend (CD) comes before Ex-dividend (XD). A stock is said to be CD
indicates that the company is paying out dividend in the near future which
serves like a preempt notice to investors. The company would have announced
the amount of dividend to be paid out but has yet to. If the shareholder sells a
CD stock, he/she is not entitled to the dividend.
There has to be a cut off date that the company has to set, so as to confirm the
list of shareholders to receive dividend. When the list is finalized, the stock is
said to go XD. Once XD status is declared, the shareholder who sells his/her
shares will still be entitled the dividends, while the new owner will not.
Usually XD stocks will be accompanied by a drop in stock price, an amount
equivalent to the dividend payout. This is consistent and fair – by giving out
the dividends, the company’s asset is said to be decreased and hence, the stock
price should fall. It is fair to the new shareholders who get the stocks after XD,
they did not receive the dividends and they are buying into a company with a
lower asset. Thus, the bottom line is dividend payout is not a concern for
buying or selling of shares.