103: UGBA Intro to Finance Lecture 2: (1/20/08)
Stock Market Some of the trading costs are hidden Bid-ask spread is hidden Bid-Ask Spread Order goes to exchange, someone needs to be on other side of order (market maker--someone in business for themselves) Quotes 2 prices: bid price (how much he is willing to buy) & ask price (how much he is willing to sell) As outsider, if you want to buy, you pay ask price, and you sell at bid price Creates a cost of trading Hidden cost because the price you would buy the stock at is higher than what you can sell Done as transactional cost As is information cost--money maker worried you know something they don't, so protect themselves Quotes difference between bid & ask Market makers operate in competitive market Financial Statements Firm needs to explain to shareholder how company has been Quarterly and annual reports Need if you are a publicly traded company Not if partnership, LLP SEC filings Established in 1930's Prospectus Detailed description of company, risks of investing, past financial records Required by SEC, whose role is to protect investors from abuses in trading securities Generally Accepted Accounting Principles (GAAP) Accounting: Double Entry System Balance Sheet at end of 1st year Stockholders were 300 Company issued bonds, bringing in 500 Current liability--need to pay this year, is 200 in this example Total is 1,000. Assets = liabilities + equities Income Statement Company had sales, generate revenues Operating expenses of materials, salaries, depreciation Government taxed 180. Get interest before calculate tax Dividends are not subtracted before calculate taxes (not tax deductible) But Interest rate (bonds) are tax-deductable Profit = net income Earnings per share (EPS) = profit / number of shares Earnings per Share most important to know
Retained earnings = At end of year, cash position changed. has Balance Sheet at end of 2nd year Receivables--part of 1000 of revenue, most was paid for, but some you deliver but not paid for yet 50 is receivable Inventories changed slightly--350 of inventory Total is $1,050 Retained Earnings = shareholder value (paid-in-capital) + surplus If company issue more stock, greater paid-in-capital Compared to 1st year Still owes 10% on bonds, another 50 in surplus Book value per share = (paid-in-capital + surplus) / number of shares Market price per share Shares sold in market may be greater than book value Ex. Microsoft developed operating system, company did not receive revenue (on accounting statements) to reflect everything, including growth potential. People willing to pay more for stock because of growth potential. Ex. In farming business, produce pineapples. 200 years ago bought land (which doesn't depreciate), accountants don't factor increase in value of land because firm will look more profitable than it should if value calculated incorrectly. Accountants do not let firms tell shareholder their true value. Main asset is not pineapple business, but land, because it had appreciated so much. Ex. Guess about value of deprecation may be wrong, cause overstatement Security analysts--analysts that follow specific industries, find market price per share of companies Talk to company treasurer, don't look so much at financial statements because anyone can look at that Insider information--illegal to give and trade insider information, because hurt people who do not have that information Laws because it's unfair, and don't want to discourage people from using the market Dividend yield is 6% per year Total return = dividend yield + capital gains (increase in stock price) P/E ratios Debt-equity ratio Liabilities = 700, equities=400 How much should be debt, how much should be equity? Risk of companies