1 (of 25) FIN 200: Personal Finance Topic 17–Stock Analysis and Valuation Lawrence Schrenk, Instructor

2 (of 25) Learning Objectives 1. Explain the function of stocks in the economy. ▪ 2. Describe what a stock is. ▪

3 (of 25) The Function of the Stock Market

4 (of 25) The Economics of the Stock Market The stock market allows nearly anyone to participate in the risks and opportunities of corporate America. Real returns for the past two centuries have averaged 7 percent per year. During the last 50 years, the broad S&P 500 stock index indicates that stock investors earned a 12 percent average annual rate of return.

5 (of 25) S&P 500 Source: Global Financial Data, % - 20% - 10% 0% 10% 20% 30% 40% 50% Annual Returns mean

6 (of 25) How the Stock Market Works for Savers and Investors Savers invest in the stock market to build wealth. Investors that buy a diverse portfolio of shares and hold them over long periods of time, substantially reduce their risks. Small investors can purchase stock in an equity mutual fund, a corporation that buys and holds shares of stock in many firms.

7 (of 25) How the Stock Market Works for Corporations To raise money, a corporation can :  use earnings,  borrow money, or,  sell stock. Each share of the stock is a fractional share in the firm’s future net revenues. People buy the stock of a corporation to get future dividends paid from corporate earnings and gains derived from increases in stock prices.

8 (of 25) How the Stock Market Works for Corporations The decisions of a firm’s executives influence it’s stock price. When investors believe the decisions of corporate managers will increase the firm’s future income, they buy more of the stock, driving its price up. When investors believe that bad decisions are being made, the stock’s price falls.

9 (of 25) How the Stock Market Works for Corporations Compensation packages of top managers often include stock options; further, board members are usually stockholders. If investors have confidence in management, the stock price (and thus the value of the stock options) will rise. This can bring the interests of stockholders and management into harmony.

10 (of 25) How the Stock Market Works for the Economy The stock market benefits stockholders by disciplining corporate decision makers to be more efficient and undertake the most productive projects. The share price of a corporation constantly sends signals to the listed corporation’s board of directors and managers. Changing stock prices reward good decisions and penalize bad ones. To increase the firm's value, the firm must undertake productive projects.

11 (of 25) Stock Ownership

12 (of 25) What is a Stock?

13 (of 25) What is a Stock? Stock (share, equity or stock) is part ownership of a corporation.  Shareholder, Stockholder  Dividends  Ownership, Voting Rights  Residual Claim on Assets and Earnings  Limited Liability

14 (of 25) Stock Certificate

15 (of 25) Shareholder's Rights 1. Voting Power on Major Issues 2. Ownership in a Proportional Interest of the Firm 3. Right to Transfer Ownership 4. Dividend Entitlement 5. Opportunity to Inspect Corporate Books and Records 6. Suing for Wrongful Acts

16 (of 25) Types of Stock Investors Institutional Investors Portfolio Managers Individual Investors Day Traders

17 (of 25) Dividends Distribution of a portion of a company's earnings Decided by the board of directors. Dividends per share or DPS Quarterly Variable (not legally required) Double-Taxation

18 (of 25) Stocks versus Bonds StockBond OwnershipYESNO ControlYESNO Cash FlowVARIABLEFIXED Bankruptcy TriggerNOYES Residual ClaimantYESNO

19 (of 25) Preferred Shares Hybrid Security Hybrid Security Fixed Dividend Fixed Dividend No Voting Rights No Voting Rights About 500 listed on the NYSE About 500 listed on the NYSE Moves very much like a bond Moves very much like a bond

20 (of 25) Stock Types Growth Stock Income Stock Speculative Stock Cyclical Stock Defensive Stock

21 (of 25) Stock Values Market Value: The current market price of the stock times the number of shares outstanding. Book Value: The value of the equity of the firm divided by the number of shares outstanding. Liquidation Value: The value obtained for selling all the assets of the corporation on the auction block. Par Value: A dollar amount that is assigned to a security when representing the value contributed for each share in cash or goods.

22 (of 25) Initial Public Offering (IPO) More IPOs in up markets. Overall do well the first year and then ??? Only about 20% of the company is offered the first time around. Risky Renaissance Capital

Project Note 23 (of 25)

24 (of 25) Ethical Dilemma The management of a publicly traded manufacturing company will fall short of their yearly profit goals and managers not receiving their year- end bonuses. A decision is made to notify all customers that if they will agree to accept shipments for first quarter orders prior to the end of the fourth quarter, the company will agree to pick up the shipping costs. The plan results in a significant increase in both sales and net income despite the company's increased shipping costs. The increase is sufficient to warrant payment of bonuses to the executives and managers and also results in a significant increase in the company's stock price. a. Was the incentive plan devised by the company's management for the purpose of increasing sales and profits to a level justifying bonuses ethical? Why or why not? b. Discuss any negative impact that this incentive program could have for the company and its shareholders in the future.