Equities - Equities WhatWeWillCover Defining Common...

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Equities Professor David McLean Alberta School of Business
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What We Will Cover Defining Common Stocks (Equities) Corporate Governance Book Value vs. Market Value The Dividend Discount Model (DDM) P/E Ratios Valuing Growth Opportunities Free Cash Flow Models 2
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What Is Common Stock? Common Stock or Equity “Equity” is ownership in a corporation Shareholders gave voting rights Dividends are paid to stockholders Cash dividends Stock dividends Uncertain in both magnitude and timing Equity can be sold 3
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What Is Preferred Stock? Also a type of equity, however it does not come with voting rights Similar to a bond, but if a dividend payment is missed the firm is not in default Tend to have high dividends that do not vary much over time Dividends are often cumulative; if a dividend is missed it must be paid before common stockholder can get dividends 4
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Key Characteristics of Common Stock  Residual claim on corporate assets Creditors get paid first Limited liability Cannot lose more than you invest Voting rights Elect board of directors Vote on major decisions; e.g., mergers Access to public markets 5
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Corporate Governance 6 Corporations are Republics The ultimate authority rests with voters (shareholders) These voters elect representatives (directors) who delegate most decisions to bureaucrats (managers) The Board of Directors Elected governing body, oversees management Could include managers, shareholders, and outsiders
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The Board of Directors 7 Shareholders (We the People) Board of Directors (Politicians) Management (Bureaucrats)
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Maximizing Firm Value 8 We approach the governance problem from the perspective of maximizing firm value Shareholders own the firm (the equity and free cash flow it produces, after creditors are paid) Managers work for the shareholders; they do not own the firm, so it is not theirs to do with as they please Agency problems: managers use the firm’s resources for their own benefit at the expense of the shareholders The Board’s legal obligation is to represent the shareholders and limit agency problems
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Book Value vs. Market Value Valuing firms based on book values found in accounting statements is hard to do Actual market values rarely equal book values Book values reflect accounting rules and values at time of purchase Market values can be much different 9
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Book Value vs. Market Value Accounting Equation B.V. (Equity) = B.V. (Assets) – B.V. (Debt) Market Value Equation M.V. (Equity) = M.V. (Assets) – M.V. (Debt) M.V. (Equity) = P.V. (Dividends) 10
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Book Value vs. Market Value
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