6.3 Overview of Equity Securities - 6.3 Overview of Equity Securities

Key Concepts

• Common Stock
• Preferred Stock
• Voting Rights
• Dividends
• Equity Valuation

Common Stock

Common Stock represents ownership in a company and typically entitles the holder to vote on corporate matters and receive dividends. Common stockholders are the residual owners of the company, meaning they are entitled to any remaining assets after all liabilities and preferred stockholders' claims are satisfied.

Example: If a company issues 1 million shares of common stock and you own 1,000 shares, you own 0.1% of the company. You would have a say in corporate decisions and would receive a proportional share of any dividends declared.

Preferred Stock

Preferred Stock is a type of equity that typically pays fixed dividends before any dividends are paid to common stockholders. Preferred stockholders usually do not have voting rights but have a higher claim on assets in the event of liquidation compared to common stockholders.

Example: A company issues 100,000 shares of preferred stock with a par value of $100 and a fixed dividend rate of 5%. Each share would pay an annual dividend of $5, and these dividends would be paid before any dividends are distributed to common stockholders.

Voting Rights

Voting Rights are the privileges granted to shareholders that allow them to vote on important corporate decisions, such as the election of the board of directors and significant corporate actions. Common stockholders typically have voting rights, while preferred stockholders often do not.

Example: If a company holds an annual general meeting where shareholders vote on the election of directors, common stockholders would have the right to cast their votes. Each share of common stock usually represents one vote.

Dividends

Dividends are payments made by a corporation to its shareholders, usually in the form of cash or additional shares of stock. Dividends are a way for companies to distribute profits to their owners. Preferred stockholders typically receive fixed dividends, while common stockholders receive dividends that can vary based on the company's performance.

Example: A company with $1 million in net income decides to pay out $0.50 per share in dividends to its 2 million outstanding shares of common stock. This results in a total dividend payout of $1 million. Preferred stockholders would receive their fixed dividends first, and any remaining funds would be distributed to common stockholders.

Equity Valuation

Equity Valuation involves determining the intrinsic value of a company's stock. This is typically done using various financial models, such as the Dividend Discount Model (DDM), Price-to-Earnings (P/E) ratio, and Discounted Cash Flow (DCF) analysis. Valuation helps investors make informed decisions about buying, holding, or selling shares.

Example: Using the Dividend Discount Model, if a company is expected to pay a dividend of $2 per share indefinitely and the required rate of return is 10%, the intrinsic value of the stock would be $20 per share. This means that if the stock is trading below $20, it may be undervalued, and if it is trading above $20, it may be overvalued.