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Stocks

Chapter 9

Common and Preferred Stock 9.1

Objectives

How to identify the reasons for investing in common stock

How to identify the reasons for investing in preferred stock

Common and Preferred Stock 9.1

Why it’s important

Recognizing the reasons for investing in common and preferred stock will enable you to make the best investments for your financial situation

Common and Preferred Stock 9.1

Securities

are all of the investments, including stocks, bonds, mutual funds, options, and commodities, that are traded—bought and sold—on securities exchanges or the over-the-counter market.

Common and Preferred Stock 9.1

Common Stock – (from chapter 8) is stock that provides the most basic form of corporate ownership

The company uses the money made by selling stock to make and sell its product, fund its operations, and expand

If they company earns a profit, the stockholders earn a return, or gain on their investment

Common and Preferred Stock 9.1

People buy and sell stocks for one reason: they want larger returns than they can get from more conservative investments (like savings accounts or government bonds)

Common and Preferred Stock 9.1

Why Corporations Issue Common Stock?

To raise money to start up their business and then to help pay for its ongoing activities

Private corporations

(closely held corporations) – shares are owned by a relatively small group of people and are not traded openly in stock markets

Public corporations

(publicly held) – sells its shares openly in stock markets where anyone can buy them

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Why Corporations Issue Common Stock?

A Form of Equity – corporations do not have to repay the money a stockholder pays for stock

A stockholder can sell it to another investor

The price is set according to how much the buyer is willing to pay

Dividends Not Mandatory – corporate board of directors decide whether any profits will be paid to stockholders

Common and Preferred Stock 9.1

Why Corporations Issue Common Stock?

Voting Rights and Control of the Company

In return for your money, management gives you certain rights as a stockholder (example, by law the corporation holds a meeting every year where stockholders vote on company business)

Stockholders usually get one vote for each share they own

Can vote in person or by

proxy

(a document that transfers a stockholder’s voting rights to someone else)

Common and Preferred Stock 9.1

Why Corporations Issue Common Stock?

Voting Rights and Control of the Company

Some state require that corporations offer existing stockholders a preemptive right (give the current stockholders the right to buy any new stock the corporation issues before the stock is offered to the general public)

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Why Investors Purchase Common Stock –

Income From Dividends – to keep stockholders happy, most board members vote to pay dividends as long as the company is able

Most dividends are paid quarterly (every three months) and sometimes a special cash dividend if the company has a large increase

Dollar Appreciation (increase) of Stock Value – have to decide whether to sell or keep the stock if the value goes up

If you sell the difference between the price that you paid for it and the price at which you sell it is your profit

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Why Investors Purchase Common Stock –

Possibility of Increased Value from Stock Splits

Value can increase through a

stock split

(a process in which the shares of stock owned by existing stock holders are divided into a larger number of stocks)

Example: If you had 10,000 shares at $50 a share and they split you would then have 20,000 shares at $25 a share.

Why? Sometimes management believes that the stock should be trading at an ideal price range and if the market value is a lot higher, a stock split will bring it back in line

Common and Preferred Stock 9.1

Why Investors Purchase Common Stock –

Possibility of Increased Value from Stock Splits

Why? Sometimes management believes that the stock should be trading at an ideal price range and if the market value is a lot higher, a stock split will bring it back in line

It makes the shares more attractive to investors and the price starts to rise

But the value is NOT guaranteed to go up after a split

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Preferred Stock – gives the owner the advantage of receiving cash dividends before common stockholders

You know the actual dollar amount of the dividend you will receive before you buy

It is either a specific amount of money or a percentage of the par value of the stock

Par value

- an assigned dollar value, often random, that is printed on a stock certificate for example if a par value of a stock is $30 and the dividend rate is 5%, the dollar amount of the dividend is $1.50 ($30x5%=$1.50)

Common and Preferred Stock 9.1

Why Corporations Issue Preferred Stock

As a way to raise money (used less often than common stock and only by a few corporations)

Might be attractive to conservative investors who don’t want to buy common stock

Preferred stockholders also have limited voting rights if the company is in financial trouble

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Why Investors Purchase Preferred Stock?It’s considered the “middle investment” because its safer than common stock, but not as safe as bonds

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Why Investors Purchase Preferred Stock?

People who want a steady source of income often buy preferred stock but it lacks growth potential that common stock offers

So…Preferred stocks are not considered a good investment for most people

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Why Investors Purchase Preferred Stock?

To make preferred stock more attractive to investors some corporations may offer:

Cumulative preferred stock – stock whose unpaid dividends build up and must be paid before any cash dividend is paid to common stockholders

For example: if a corporation decides to omit one or more dividend payments to preferred stockholders, then people who have cumulative preferred stock will still receive those dividend payments during a later payment period

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Why Investors Purchase Preferred Stock?

To make preferred stock more attractive to investors some corporations may offer:

Convertible Preferred Stock - stock that can be exchanged for a specified number of shares of common stock

Participation Feature – allows preferred stockholders to share in the corporation’s earnings with the common stockholders

After a required dividend is paid to preferred stockholders and a stated dividend is paid to common stockholders, the remainder of the available earnings is shared…very rare feature