1 (of 25) fin 200: personal finance topic 17–stock analysis and valuation lawrence schrenk,...
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FIN 200: Personal Finance
Topic 17–Stock Analysis and Valuation Lawrence Schrenk, Instructor
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Learning Objectives
1. Explain the function of stocks in the economy. ▪
2. 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
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
Source: Global Financial Data, http://www.globalfindata.com.
- 30%
- 20%
- 10%
0%
10%
20%
30%
40%
50%
Annual Returns
1950 1960 1970 1980 1990 2000
mean
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How the Stock Market Works for Savers and Investors 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 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 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
Banks2.0%
Households38.3%
Brokers and Dealers0.4%Funds
19.1%
Public Pension Funds11.3%
Private Pension Funds11.6%
Insurance Companies6.5%
Foreign Investors10.0%
Government0.7%
Who Owns Stock
Source: Federal Reserve Flow of Funds
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What is a Stock?
Stock (share, equity or stock) is part ownership of a corporation. Shareholder, Stockholder Dividends Ownership, Voting Rights Residual Claim on Assets and Earnings Limited Liability
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Shareholder's Rights
1. Voting Power on Major Issues
2. Ownership in a Proportional Interest of the Firm
3. Right to Transfer Ownership
4. Dividend Entitlement
5. Opportunity to Inspect Corporate Books and Records
6. 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
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
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
Growth Stock Income Stock Speculative Stock Cyclical Stock Defensive Stock
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Stock Values
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)
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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Ethical DilemmaThe management of a publicly traded manufacturing company will fall short of their yearly profit goals and managers not receiving their year-end 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.