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Reading 39 Overview of Equity Securities - Coggle Diagram
Reading 39 Overview of Equity Securities
Equity Security Characteristics
Common Stock
Common shareholders have a residual claim to firm assets
Common shareholders vote for board members
Different classes of common shares can have different voting rights
cumulative voting:
allow minority shareholders to have greater representation
Example: 3 board position are up for vote, shareholder owns 100 shares
Statutory voting: Shareholder can give maximum of 100 votes to each of 3 candidates
Cumulative voting: Shareholder can give maximum of 300 votes to 1 candidate
Dividends are variable, no obligation to pay dividends
Preferred Stock
Similar to common stock
Dividends not an obligation
No maturity date
Similar to debt
Fixed payment (scheduled dividends)
Usually no voting rights
Does not participate when firm does well
Types of Preferred Stock
Cumulative preferred:
Must receive any unpaid dividends before common shares may be paid dividends
Less risk than non-cumulative preferred shares
Participating preferred
Receives extra payment if firm does well
Claim can exceed par value if firm is liquidated
Convertible preferred
Preferred shares can be converted to common shares at a conversion ratio
Pros:
Preferred dividend > Common dividend
Shareholders can benefit from firm growth by converting to common
Less risky than common stock
Callable vs. Putable
Callable Preferred Stock: Give FIRM the right to repurchase the shares at the call price; more risk than regular shares
Putable Preferred Stock: Give SHAREHOLDERs the right to sell the share back to the firm at the put price; less risk than regular share
Less risky than common stock
Fixed dividend
Receives distributions before common stock
Claim to par value if firm is liquidated; after claims of debt holders but before claim of common stockholders
Private Equity
Pros:
Less reporting requirement
More able to focus on long term
Potentially greater return for investors once the firm goes public
Cons:
Less liquid
Less ability to raise capital
Less disclosure / transparency
May weaken governance
Private Equity Investments
Venture Capital: Provides financing for early stages of firm development
Leverage Buyout (LBO): Use debt to buy all outstanding stock
Management Buyout (MBO): Management-led LBO
Private Investment in Public Entity (PIPE): Public firm raises equity capital in private placement
Foreign Equity
Direct Investment in Foreign Equity
Cons:
Investment and return may be denominated in foreign currency
Often less liquid
Often less transparent
Exchange regulations and procedures may be quite different
Depository Receipts
Shares are deposited in a bank
Claims to deposited shares (receipts) trade like a local stock in local currency
Accounting standards and market procedures are those of the local market, not those of the bank
Types
Sponsored
Firm is involved with issue
Same voting and dividend rights as shareholders
Greater reporting requirements (SEC in U.S)
Unsponsored
Depository buys shares in foreign market
Bank retains voting rights
Base on geography
Global Depository Receipts: Issued outside U.S, outside firm's home country, most denominated in USD
American Depository Receipts: Issued in US; denominated in USD; trade on U.S Exchanges, oldest and most common type
Global Registered Shares: Identical common shares that trade in local currencies on stock exchanges worldwide
Baskets of Listed Depository Receipts: ETFs; portfolio of depository receipts
Return Characteristics of Equity
Components of equity return
Dividends
Capital gain or loss
Share repurchases
Possbile foreign exchange gain or loss
Compounding of reinvested dividends: has historically been an important part (>66%) of investors compound returns on equity securities
Equity Issuance
Provide funds to buy productive assets to increase shareholder wealth
Can be used to buy other companies or for employee incentive compensation
Decreases firm's reliance on debt financing
Value measurement
Book value
Value of the firm's balance sheet (assets - liabilities)
Market value
Reflects investor expectations regarding firm risk and the amount and timing of future cash flows
ROE:
Measure the return that management is generating on equity
\(ROE = \frac{Net.Income}{Equity}\)
Cost of Equity:
is investor's minimum required rate of return on the firm's equity securities
Difficult to estimate compared to Required Return on Debt