FIN 200:
Personal Finance
Topic 17–Stock Analysis and Valuation
Lawrence Schrenk, Instructor
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Learning Objectives
1.
2.
Explain the function of stocks in the
economy. ▪
Describe what a stock is. ▪
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The Function of the Stock
Market
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The Economics of the Stock Market


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The stock market allows nearly anyone to
participate in the risks and opportunities of
corporate America.
Real returns for the past two centuries
have averaged 7 percent per year.
During the last 50 years, the broad S&P
500 stock index indicates that stock
investors earned a 12 percent average
annual rate of return.
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S&P 500
Annual
Returns
mean
50%
40%
30%
20%
10%
0%
- 10%
- 20%
- 30%
1950
1960
1970
1980
1990
2000
Source: Global Financial Data, http://www.globalfindata.com.
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How the Stock Market
Works for Savers and Investors

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Savers invest in the stock market to build
wealth.
Investors that buy a diverse portfolio of
shares and hold them over long periods of
time, substantially reduce their risks.
Small investors can purchase stock in an
equity mutual fund, a corporation that buys
and holds shares of stock in many firms.
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How the Stock Market
Works for Corporations

To raise money, a corporation can :





use earnings,
borrow money, or,
sell stock.
Each share of the stock is a fractional share
in the firm’s future net revenues.
People buy the stock of a corporation to get
future dividends paid from corporate earnings
and gains derived from increases in stock
prices.
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How the Stock Market
Works for Corporations

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The decisions of a firm’s executives influence
it’s stock price.
When investors believe the decisions of
corporate managers will increase the firm’s
future income, they buy more of the stock,
driving its price up.
When investors believe that bad decisions
are being made, the stock’s price falls.
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How the Stock Market
Works for Corporations


Compensation packages of top managers
often include stock options; further, board
members are usually stockholders.
If investors have confidence in management,
the stock price (and thus the value of the stock
options) will rise. This can bring the interests
of stockholders and management into
harmony.
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How the Stock Market
Works for the Economy

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The stock market benefits stockholders by
disciplining corporate decision makers to be more
efficient and undertake the most productive projects.
The share price of a corporation constantly sends
signals to the listed corporation’s board of directors
and managers.
Changing stock prices reward good decisions and
penalize bad ones.
To increase the firm's value, the firm must undertake
productive projects.
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Stock Ownership
Who Owns Stock
Funds
19.1%
Brokers and Dealers
0.4%
Households
38.3%
Public Pension Funds
11.3%
Private Pension Funds
11.6%
Insurance Companies
6.5%
Banks
2.0%
Government
0.7%
Foreign Investors
10.0%
Source: Federal Reserve Flow of Funds
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What is a Stock?
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What is a Stock?

Stock (share, equity or stock) is part
ownership of a corporation.




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Shareholder, Stockholder
Dividends
Ownership, Voting Rights
Residual Claim on Assets and Earnings
Limited Liability
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Stock Certificate
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Shareholder's Rights
1.
2.
3.
4.
5.
6.
Voting Power on Major Issues
Ownership in a Proportional Interest of the
Firm
Right to Transfer Ownership
Dividend Entitlement
Opportunity to Inspect Corporate Books and
Records
Suing for Wrongful Acts
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Types of Stock Investors
Institutional Investors
 Portfolio Managers
 Individual Investors
 Day Traders

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Dividends



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Distribution of a portion of a company's
earnings
Decided by the board of directors.
Dividends per share or DPS
Quarterly
Variable (not legally required)
Double-Taxation
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Stocks versus Bonds
Stock
Bond
Ownership
YES
NO
Control
YES
NO
Cash Flow
VARIABLE
FIXED
Bankruptcy Trigger
NO
YES
Residual Claimant
YES
NO
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Preferred Shares

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Hybrid Security
Fixed Dividend
No Voting Rights
About 500 listed on the NYSE
Moves very much like a bond
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Stock Types

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Growth Stock
Income Stock
Speculative Stock
Cyclical Stock
Defensive Stock
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Stock Values

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Market Value: The current market price of the stock
times the number of shares outstanding.
Book Value: The value of the equity of the firm
divided by the number of shares outstanding.
Liquidation Value: The value obtained for selling all
the assets of the corporation on the auction block.
Par Value: A dollar amount that is assigned to a
security when representing the value contributed for
each share in cash or goods.
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Initial Public Offering (IPO)
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More IPOs in up markets.
Overall do well the first year and then ???
Only about 20% of the company is offered
the first time around.
Risky
Renaissance Capital
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Project Note
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Ethical Dilemma
The management of a publicly traded manufacturing company will fall
short of their yearly profit goals and managers not receiving their yearend bonuses. A decision is made to notify all customers that if they will
agree to accept shipments for first quarter orders prior to the end of
the fourth quarter, the company will agree to pick up the shipping
costs. The plan results in a significant increase in both sales and net
income despite the company's increased shipping costs. The increase
is sufficient to warrant payment of bonuses to the executives and
managers and also results in a significant increase in the company's
stock price.
a. Was the incentive plan devised by the company's management for the
purpose of increasing sales and profits to a level justifying bonuses
ethical? Why or why not?
b. Discuss any negative impact that this incentive program could have for the
company and its shareholders in the future.
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