STOCKS AND STOCK
VALUATION
Chapter 9
Dr. David P. Echevarria
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1
I. PREFERRED STOCK
A. Hybrid Security;
1. Fixed dividends [like bonds].
2. Equity investment similar to common stock.
3. Preferred riskier than bonds; dividends paid from
after tax income.
Dr. David P. Echevarria
All Rights Reserved
2
I. PREFERRED STOCK
B. Attributes of Preferred Stock
1.
2.
3.
4.
5.
6.
Par value.
Cumulative Feature
Participating; high profits  extra dividend.
Non-Voting; exceptions provided in charter.
Convertibility; typically into common.
Some dividends are partially tax exempt (returns
of capital).
Dr. David P. Echevarria
All Rights Reserved
3
II. COMMON STOCK
A. Classes of Common
1. Voting; the "vanilla flavor."
2. Non-Voting: some classes may be non-voting
(unusual).
B. Dividend Policy
1. Declaration date, Record date, and Payment date.
2. Cash vs. Stock Dividends vs. Stock Splits.
3. Automatic Dividend Reinvestment Plans.
Dr. David P. Echevarria
All Rights Reserved
4
III. REPURCHASE OF STOCK
A. Implied statements about investment
opportunity set.
B. An important alternative to paying cash
dividends to increase/maintain values.
C. Reduction in outstanding shares makes shares
more expensive.
Dr. David P. Echevarria
All Rights Reserved
5
IV. VALUATION OF PREFERRED STOCK
A. Valuation model; the perpetuity assumption.
Dividend
VPFD 
k PFD
B. Impact of changes in interest rates; bond-like
behavior.
1. Preferred Stock dividends tend to be fixed.
2. Fixed dividends makes preferred stock prices
sensitive to changes in interest rates.
Dr. David P. Echevarria
All Rights Reserved
6
V. VALUATION OF COMMON STOCK
A. Dividend-Growth Valuation Model
1. Zero Growth Model (same as preferred model).
D1
Ve 
ke
2. Normal Growth; the growth in dividends over time.
D1
Ve 
ke  g
Dr. David P. Echevarria
All Rights Reserved
7
V. VALUATION OF COMMON STOCK
B. P/E Ratios & Valuation of Common Stock;
1. Normal valuation models not viable for nondividend paying stocks.
2. Models don't capture other aspects of firm (nonincome items).
3. Implied Earnings-Yield (E/P ratio).
Dr. David P. Echevarria
All Rights Reserved
8
HOMEWORK CHAPTER 9
A. Self-Test: ST-1, a, b, f
B. Questions: 9-2
C. Problems: 9-1, 9-3, 9-6
Dr. David P. Echevarria
All Rights Reserved
9