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Fin358 Lecture Notes Chapter 6

COMMON STOCKS

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143 views17 pages

Fin358 Lecture Notes Chapter 6

COMMON STOCKS

Uploaded by

my chimchim
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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CHAPTER 6: COMMON SHARES

Outlines:

 Definition of common shares


 Characteristic of common shares
 Types of common shares
 Advantages and disadvantages of
investing in common shares
 Advantages and disadvantages of
issuing common shares
 Calculation of ratios and
interpretations
 Common shares valuation
DEFINITION OF COMMON SHARES

Alexander et al, (1993)

• Common stock represents equity, or an ownership


position in a corporation

Madura (1988)

• Similar to preferred stock, common stocks are equity


sources of financing because they represent
ownership of the firm. Therefore, any net income
generated by the firm belongs to the owners of the
common and preferred stock.
CHARACTERISTICS OF COMMON
SHARES

• In the case of the firm’s


bankruptcy, common • Only the owners of
shareholders are the last common stock are
ones to be paid after permitted to vote on
payments have been made certain key matters
to the bondholders and concerning the firm
preferred shareholders.

Common Stock
is a Residual Voting Right
Claim
CHARACTERISTICS OF COMMON
SHARES

• Not fixed • No maturity


• Not compulsory • Can be trade
• Sometimes not anytime,
declared by BOD anywhere

Dividend Maturity
CHARACTERISTICS OF COMMON
SHARES

• The right of existing


shareholders to purchase all
new shares of common stock
• The owners’ liability in the case being sold by firms. The
of bankruptcy is limited to the purpose of this right is to
amount of their investment prevent existing shareholders
from unwillingly losing their
proportionate ownership
position of the firm.

Limited Preemptive
Liability Right
Blue Cyclical
Chips Stock

Income Defensive
Stock Stock

TYPES OF
Growth Speculative
COMMON
Stock Stock
SHARES
BLUE CHIPS

Potential for price


Reasonable DY Low price volatility
appreciation

The shares make


profit in good and
Acceptable total rate
bad times and have a
of return
low risk of capital
loss.
INCOME STOCKS

Risk averse investors are suitable to buy these income


stocks as they are safer and have high level of current
income in the form of dividends.

Low P/E ratio

High DPR

Little growth in terms of price


GROWTH STOCK
Has experienced and is expected to continue
experiencing consistently high rates of
growth in operations and earnings.

Chosen by those who seek long-term capital


gains through price appreciation.

High P/E ratio

Low DPR

Low DY
TECH STOCK

Issued by technological component company

Include company that produced component computer, semi-conductors,


data storage, internet services, networking etc.

Listed in ACE market

Attractive returns

High risk, suitable for risk taker investor


SPECULATIVE STOCK

Issued by companies with highly unstable


earnings records and very uncertain future
earnings

Subjected to wide swings in


price and usually pay little or
no dividends to their investors

Most risky
CYCLICAL STOCK

Attractive when the


Performance of stock economic condition in a
fluctuates according to country is strong, and best
fluctuation in business avoided when the
cycle economy begins to
weaken
DEFENSIVE STOCK

Stocks remain
stable or even rise
during economic
downturns.

Rise or decline at
a lower rate than
the market in
general.
ADVANTAGES AND DISADVANTAGES OF
INVESTING IN COMMON SHARES
A D VA N TA G E S
• Better hedge against inflation
• Expected returns are higher
• Capital appreciation on investment
• Ownership position in a corporation through voting rights
• Enjoyment preemptive rights
• Possibility of being elected to the Board of Directors
• Easily marketable at the stock exchange

D I S A D VA N TA G E S
• Bear the highest risk in the company
• Possibility of not receiving residual assets of the company in case of
liquidation
• Company is not obligated to pay dividend if directors think that the
company is not in the position to do so.
• Dividends do not enjoy tax shield
• Tax rate on dividends is high
ADVANTAGES AND DISADVANTAGES OF
ISSUING COMMON SHARES

• The firm is not legally obligated • The costs of underwriting and


to pay common stock dividends distributing common stock are
• Because common stock has no usually higher because of its
maturity date, the firm does not higher investing costs and stocks
have a major cash outflow are riskier then debt.
associated with its redemption • Common stock dividends are not
• By issuing common stock the deductible as an expense for
firm increases its financial base calculating the corporation’s
and thus its future borrowing taxable income
capacity • The issuance of new common
stock may result in a change in
the ownership and control of a
firm.

ADVANTAGES DISADVANTAGES

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