Equity Markets Chapter 9 May 04 Common Stock vs. Preferred Stock
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Chapter 9 May 04 1 2 Common Stock vs. Preferred Stock Common Stock Owners of the Firm Claim on Assets and Earnings not claimed by other creditors aka Residual Claim Voting Rights Vote for Board of Directors Preferred Stock Equity Markets and Stock Valuation A hybrid security with both debt and equity characteristics. Has priority over common stock in receipt of dividends and in liquidation. Dividends are fixed as a percentage of par value. Only participating preferred stock (which is rare) shares in the residual income with the common stockholders. 3 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 4 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Source: Wall Street Journal Company Issuing the Stock Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Preferred Stock Chapter 9 May 04 5 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s Net Close Chg Hi Lo 143036 1669 1444 1638 +150 126999 95 2588 3831 7025 8375 2531 3638 6750 9463 2538 3644 7025 +981 +031 -113 +225 85 5609 35 6 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s Hi Lo 143036 1669 1444 126999 95 2588 3831 7025 8375 2531 3638 6750 85 5609 35 Source: Wall Street Journal Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Annual Dividend per Share Ticker Symbol Where: .52 = 52¢ per share paid annually Apple Computer is not currently paying a dividend 7 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 8 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Source: Wall Street Journal Volume of Trading for the day Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Daily Trading Range 1669= $16.69 Chapter 9 May 04 9 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s Net Close Chg Hi Lo 143036 1669 1444 1638 +150 126999 95 2588 3831 7025 8375 2531 3638 6750 9463 2538 3644 7025 +981 +031 -113 +225 85 5609 35 10 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s Hi Lo 143036 1669 1444 126999 95 2588 3831 7025 8375 2531 3638 6750 85 5609 35 Source: Wall Street Journal Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Price Change from Previous Day Trading $ Closing Price (Market Price--Denoted as P0) Note: Decimalization 11 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 12 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Source: Wall Street Journal Trading Range for Last Year Where: s denotes recent stock split (prices shown adjusted for split), and Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Dividend Yield Investor’s return from dividend only (assumes constant stock price) Dividend Yield = Dividend Closing Price Chapter 9 May 04 13 Stock Quote 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Yld Div % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 14 Valuing Preferred Stock 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal Source: Wall Street Journal 0 1 D1=1.88 Price to Earnings (PE) Ratio (Indicates market premium for given common stock) PE Ratio = s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 1444 8375 95 2588 2531 3831 3638 7025 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 0 1 D1=1.88 P0 = 1.88 (1+ kp ) 3 ∞ D3=1.88 D∞ =1.88 2 D2=1.88 + 1.88 (1+ kp )2 + 1.88 1.88 ∞ (1+ kp )3+···+ (1+ kp ) In General: Perpetuity P0 = D R = 1.88 .10 = $18.80 D3=1.88 D∞ =1.88 Buy? 16 Valuing Common Stock Intrinsic Value P0 = PV of ALL received dividends discounted at investor’s Required Rate of Return 0 D0 Source: Wall Street Journal R=10% ∞ = PV of ALL dividends discounted at investor’s Required Rate of Return 15 Valuing Preferred Stock D2=1.88 3 P0 = Intrinsic Value of Preferred Stock Closing Price Earnings per Share No PE for Preferred stock because preferred stock investors not entitled to RESIDUAL Earnings 52 Weeks Hi Lo Stock 2 ? > < = 1 D1 ? > < = 2 D2 ? > < = 3 D3 ? > < = Unlike Preferred stock Dividends, Common Stock Dividends may vary over time ∞ D∞ Chapter 9 May 04 20 Valuing Common Stock Constant Growth Model Assume that dividends & price grow at a constant rate (g). 0 D1=D0 (1+g) Constant Growth Model-EXAMPLE Assume that dividends & price grow at a constant rate (g). 2 3 ∞ D2=D0 (1+g)2 D3=D0 (1+g)3 D∞=D0 (1+g)∞ 1 D0 21 Valuing Common Stock 0 1 2 ∞ 3 D1=D0 (1+g) D2=D0 (1+g)2 D3=D0 (1+g)3 D∞=D0 (1+g)∞ = 0.52(1.12) = 0.52(1.12)2 = 0.52(1.12)3 = $0.58 = $0.65 = $0.73 D10 = ? Assume g=12% for IBM common stock D0 0.52 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal 25 Valuing Common Stock 52 Weeks Hi Lo Stock Constant Growth Model Assume that dividends & price grow at a constant rate (g). 0 D0 P0 = D1=D0 (1+g) s 2 3 ∞ D2=D0 (1+g)2 D3=D0 (1+g)3 D∞=D0 (1+g)∞ 1 D0 (1+ g) D0 (1+ + (1+ k )2 (1+ ks ) s g)2 + D0 (1+ g)3 D0 (1+ g)∞ (1+ ks )3 +···+ (1+ ks )∞ 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s Hi Lo 143036 1669 1444 126999 95 2588 3831 7025 8375 2531 3638 6750 85 5609 35 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal General Model P0 = Reduces to: P0 = 26 Valuing Common Stock D0(1+g) D1 = R– g R– g Assume growth =5% and Investor requires a 11% rate of return on this investment D0(1+g) D1 = R– g R– g Requires R> g P0 = 2.18(1+.05) = 2.289 = $38.15 .06 .11 – .05 Buy? Chapter 9 May 04 27 Stockholders Expected Rate of Return Market price of stock shows the rate investors are expecting to earn on their investment. Similar to Yield to Maturity for a Bond Substitute the market determined stock price for intrinsic value and solve for the required rate. Stockholders Expected Rate of Return 28 Preferred Stock P0 = D R R= D Po Substitute the market determined stock price for intrinsic value and solve for the expected rate of return (R) on this investment. 29 Stockholders Expected Rate of Return Preferred Stock 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Stockholders Expected Rate of Return Common Stockholders-Constant Dividend Sym Yld Div % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Source: Wall Street Journal R= R= D P0 5.00 = .0712 = 7.12% 70.25 If you have determined your required rate should be 7.25%, would you purchase ConEd pf stock? IBM pf? General Model P0 = D0(1+g) R– g Intrinsic Value Substitute the market determined stock price for intrinsic value and solve for the expected rate of return (ks) on this investment. R = D0(1+g) +g P0 Next year’s Dividend Yield Capital Gains Yield Market Price 30 Chapter 9 May 04 31 Stockholders Expected Rate of Return 52 Weeks Hi Lo Stock s 7519 1363 13484 8006 2625 25 3950 2619 7313 5950 Sym Div Yld % PE AppleCptr AAPL 8 IBM IBM .52 .5 23 IBM pf 1.88 7.4 … ConEd ED 2.18 6.0 12 ConEd pf 5.00 7.1 … Vol 100s 143036 126999 85 5609 35 Hi Lo 1669 95 2588 3831 7025 1444 8375 2531 3638 6750 Net Close Chg 1638 9463 2538 3644 7025 +150 +981 +031 -113 +225 Stockholders Expected Rate of Return Relationship between Expected Rate of Return and Intrinsic Value for Preferred and Common Stock Given Required Rate of Return Compute Intrinsic Value Compare Intrinsic Value to Market Price Source: Wall Street Journal D0(1+g) + g P0 R = 2.18(1+.08) + .08 36.44 R = Assume g = 8% Market Price Expected Rate of Return If required rate = 14% Buy? = .0646 + 0.08 = .1446 = 14.46% Unlike Preferred stock, the Dividend Yield from the quote DOES NOT equal the expected rate of return for common stock Expected Rate of Return to Required Rate 32
