Introduction to Finance: Chapter 11 - Stocks PDF

# Introduction to Finance ## Chapter 11: Stocks **Balázs Fazekas, PhD** *Assistant Lecturer* DE-GTK, Institute of Finance and Accounting ## Typical Structure of Funding Sources * **Assets** * **L&E** (Liabilities and Equity) * **Equity** * Stocks * Reinvested profits...

# Introduction to Finance ## Chapter 11: Stocks **Balázs Fazekas, PhD** *Assistant Lecturer* DE-GTK, Institute of Finance and Accounting ## Typical Structure of Funding Sources * **Assets** * **L&E** (Liabilities and Equity) * **Equity** * Stocks * Reinvested profits * Private equity * Subsidy * **Debt (Liabilities)** * Shareholder loan * Loan/credit * Payables * Lease * Bonds * **Scheme of balance sheet** ## Definition of Shares * **Security issued by firms representing membership and ownership rights** * **The shareholders are the owners of the firm** * **Equity-type funding:** * When issued, it increases the par value of stocks. * If the securities are issued on premium, it also increases capital surplus. * **External Funding:** ## Features of Shares * **No maturity (no repayment of capital)** * **Represent ownership rights:** * Ownership stake par value/registered capital * **Limited liability:** * The owner's liability is limited: The shareholder is liable for the debt of the firm only up to the value of the share. * **Uncertain yields:** * No guaranteed cash flows * Sources of profits: dividend and capital gain ## Rights of Shareholders * **Right to participate in the general meetings:** * Proposals, reports, voting rights * **Minority Rights:** * A given proportion of votes (usually 5%) is able to initiate general meetings. * **Entitled for Dividends** * **Liquidation Rights:** * The shareholder is entitled for getting a share-proportionate part of the divisible money after liquidation. * Shareholders are the last in the liquidation order. ## Private Company Limited by Shares vs Public Limited Companies * **In private companies limited by shares, the founders provide the capital, and the shares cannot be traded on public markets.** * Private trading * **In public limited companies, there is a public offering: all the market investors are able to trade with the securities.** * IPO: initial public offering * Public trading ## Bid and Ask Prices **Bid:** * The price where market participants are willing to buy the security. * If we hold the share, this is the price, where we can sell it. **Ask:** * The price where market participants are willing to sell the security. * If we want to buy the share, this is the price where we can get it. **Ask > Bid** * The difference of the prices is the bid-ask spread. * The more liquid the market is, the lesser the spread is ## Market Capitalization * **Market capitalization is the market price of all the issued shares (the market value of equity).** * **Calculation:** * **Market capitalization = number of shares * market price of shares** * **Market capitalization vs. book value of equity:** * **Book Value of Equity:** Focus is on historical events * **Market Value of Capital:** All the information of trading; expectations regarding the future. ## 2. Types of Shares 1. Common Shares 2. Preference Shares 3. Redeemable Shares 4. Warrant ## Common Shares * Grants the traditional ownership rights * Entitles for dividends * Voting rights * Motivation of investors * Dividends * Capital gains * Strategic goals * Traded on the secondary markets * Mandatory for PLCs ## Preference Share * **Gives an advantage in the dimension of one right:** * **Preferred dividend:** Grants the right to get dividend payment from the divisible income prior to other shareholders. * **Preferred voting rights:** More voting right than the proportion of capital contribution (special case is the veto right). * **Preferred rights in liquidation:** In case of liquidation, these shareholders receive payment prior to the other shareholders. * **In other dimensions, their rights are limited:** * Shareholders with preferred dividends are not entitled for voting. * Not traded publicly ## Redeemable Shares * Redeemable shares are shares that a company has agreed it will, or may, redeem (in other words buy back) at some future date. * Strategic considerations of the company ## Warrant * A type of call options that gives the right (but not the obligation) to its owner to buy the firm's stock on a pre-fixed price in the future for a fee payment in the present. * Warrants are potential equity-type securities. * If the owner of the warrant wishes to exercise its rights, the firm must sell shares on the pre-arranged price. ## Holding Period Return * How much % return can we achieve by holding a share for a finite time period. * There are 2 sources of the returns: * Dividend gain * Capital gain * The holding period return is (for 1 period): $HPR = \frac{D_1 + P_1 - P_o}{P_o}$ ## What is Dividend? * **Cash paid to shareholders** * **The source of dividend payment is the profit of the firm** * **Shareholders are entitled to dividend payment proportionally to the number of their shares** * **Paying dividends is optional** ## Economic Meaning of Dividend **For Shareholders:** * **Rent after their capital contribution** * **Income** **For the Firm:** * **Cash excluded from the operation of the firm** * **Decrease in internal funding** * **Cost of equity funding** ## How Do We Pay Dividends? * **Earnings per share (EPS):** *net income / number of shares* = EPS * **Total Dividends:** *EPS * d* = DIV * Dividend payout ratio: *total dividends / net income* = d * **Dividend per share (DIV):** *total dividends / number of shares* = DIV * **Re-invested Profits (Increase in Retained Earnings):** * Retention rate: *re-invested profits / net income* = (1 - d) ## Thank you for your attention!