Welcome to Finance in Excel, video number 59.
Hey, if you want to download these PowerPoints or the Excel
workbooks for Chapter 7, click on the link
directly below the video.
And then scroll down to the finance class.
Hey, we're in Chapter 7.
We've got to talk about stocks.
Last chapter, we talked about bonds.
And we looked some characteristics of bonds
and a lot of the math for valuing bonds.
In this chapter we're going to talk a little bit about stocks
and look at just one type of valuation model used
for valuing stocks.
Hey, stocks and bonds--
what are they really?
Oh, yeah, our basic accounting and finance formula-- assets
equal liabilities plus equity.
Bonds-- one way to get cash into the corporation
to buy profitable assets.
Equity-- stocks, right?
Another way to get cash into the firm to buy profitable assets.
So that is the point.
We get cash in.
We think we have a good idea--
we want to buy a company or some new trucks, or whatever it is.
We either issue debt or equity.
Now, bondholders are creditors.
They have a fixed claim to cash flow, right?
Oh, yeah, we did that last chapter.
It was relatively easy to figure out how much a bond is worth,
because it's a contract.
The cash flow is there.
Stockholders are owners, not creditors.
They have a residual claim to cash flow.
What does residual mean?
Whatever is left over.
So what this means is that after paying all the bondholders,
if there's any money left over, the board of directors
will declare some dividends.
And then the stockholders will get cash from called dividends.
Also, bondholders are first in line
when the company goes bankrupt.
That's another meaning of the word residual.
Whatever's left over in bankruptcy,
the stockholders get.
All right-- difference between debt and equity?
Debt is not an ownership interest.
Equity is an ownership interest.
Hey, what's the upside of equity, right?
We said residual, residual.
It sounds like debt's really good.
That's the way to go.
Ah-- but if you're an owner and the company
is wildly successful, you're not bound by a contract
which says pay 5% interest.
You can get the upside, which can be a lot greater.
You bear the risk, though, of if the company goes under you,
you're going to lose everything.
Creditors do not have voting rights.
Ah, stockholders-- common stockholders, mostly--
vote for the board of directors, and sometimes other issues.
The board of directors, then, hires the manager.
So you get to decide how the company's
run, or in theory, anyway.
Interest is considered a cost of doing business.
And boom-- tax deductible, right?
So if you have a deduction on your tax return,
that's as if there is cash coming in.
You get to avoid, whatever the amount is, that much in taxes.
Dividends are not considered a cost of business
and are not tax deductible.
In fact, they're taxed twice, right?
The profit was taxed once.
And then when you pay it out to shareholders,
they're taxed again.
Creditors have a legal recourse if interest or principal
payments are missed.
It's a contract.
So if you don't pay, you can sue.
Dividends are not a liability of the firm.
And stockholders have no legal recourse
if dividends are not paid.
And ultimately, all stocks have to pay out dividends.
But during the early years of a company,
when they're just conserving their cash and reinvesting it,
or when a company gets in trouble,
if the board of directors do not declare dividends,
the stockholder just has to sit there and go,
oh well, I'm not getting any cash.
Excess debt can lead to financial distress
and bankruptcy.
Oh, an all-equity firm cannot go bankrupt, right?
You could lose all your money.
But you're not going to go bankrupt
because it's all yours.
All right, now we need to talk about common stock,
and then compare that to preferred stock.
And sometimes there's other types of stock.
Hey, you buy one stock.
You get to vote for the directors of a corporation, who
in turn decide the managers to hire.
So you kind of get to decide how the company works.
Generally, one stock equals vote for director position
on a board of directors.
Now, this is not always the case,
because stock is a contract, right?
So some companies have written up
contracts where maybe they have one stock
and they get three votes, or something.
But this is common stock.
And this is generally true.
Of course, if you buy one stock, you get dividends.
And you get a claim to any remaining assets in bankruptcy,
after the creditors.
Some more features of common stocks--
voting rights.
Stockholders elect directors-- yeah, we talked about that.
But let's talk about cumulative, straight, and proxy voting.
Cumulative is a type of voting designed
to help shareholders who don't have a large number of stocks.
So directors are elected all at once, right?
So however many directors there are-- if you have one stock
and there's four directors, you have four votes.
So when the directors are elected all at one time,
then you can pile all of your votes
into one particular candidate.
Straight voting, directors are elected one at a time.
So here, you have one stock, four directors,
who get four votes, right?
But here, you're just going to have one vote.
And so ultimately, you need more than 50%
of the stock to vote in all your directors
and control with straight voting.
And again, that's determined by contract.
There's an example in the book, and I actually
have an example over here on the slide,
and in the Excel workbook.
I'm not going to go through it.
But with cumulative voting, if the votes
are staggered-- which means there's
four board of directors, but if you only vote for them, two,
and then later you vote for two, the fewer directors,
the less helpful this is.
The more directors are voting in at once,
the more helpful cumulative voting
is for the minority stockholder.
All right, proxy voting-- that just means you
can let someone else vote for you.
By the way, isn't this annoying?
I did handwritten notes in all the earlier ones.
But now I'm using PowerPoint.
And I'm not even running the PowerPoint.
I don't like PowerPoint so much.
But there was so much typing, I didn't want to write it out.
The handwritten notes are great for when there's
lots of pictures and diagrams.
All right, proxy voting--
letting someone else vote for you.
Yeah, if you have just a few stocks here and there,
maybe the institutional investors who
have a lot of the stock, like pension funds and things
like that, they might go out and they
know that you're not really going to vote.
So they try to go out and collect your votes, asking
you to let them vote for you.
So that's letting someone else vote.
And so a proxy fight is when two institutional investors
will try and get as many people to give them their proxy vote,
so they can accumulate enough votes to accomplish whatever
it is they want to accomplish.
Voting-- there's some other slides here,
if you want to look at them.
We need to talk about classes of stock.
Now, most stock is like we described.
It's common stock.
And then there's this thing called preferred stock
that we'll talk about in just a moment.
But sometimes there's different contracts, right?
So there really can be many different types of stocks.
For example, at Google the founders
wanted the company to not be evil.
That's their mission statement.
And also, their mission statement
is to put together all the world's information
and make it easily available to everyone, but not be evil.
And so what happened when they went public--
the original creators of Google, they
decided to create their own special class of stock.
And so they created this type of stock
to give them more voting rights.
I don't remember exactly what the number of votes are.
But when they have one stock, that
entitles them to vote a lot more times than other people.
This way, they can keep control.
So ultimately, anytime you have a stock with a contract that
gives you more voting rights, the goal
is to control the voting of the directors, et cetera.
All right, some other features in common stocks--
share proportionally in declared dividends.
All that means is if they declare $0.25 per share,
you have 10 shares, that means you get 10 quarters.
Share proportionately in remaining assets--
same thing.
Whatever the proportion you have,
that's the proportion of the assets
you'll get during liquidation.
Also, common stock often has a preemptive right.
And what this means is if you have 10% of the company
and they're going to go out and offer new stock,
you have the right to keep that 10%.
So whatever number of the new stock issue,
then you have the right to buy that many
so you can keep your 10%.
Sometimes there's special voting on special issues
that the common stock contract might allow, for example,
mergers.
Now, dividends-- next slide, dividends.
Dividends, we already mentioned that not a liability
of the firm until the dividend has been declared by the board.
And firms cannot go bankrupt for not declaring dividends.
Ah-ha, but if they don't pay interest,
that debt side of it--
you bet, the contract allows the creditors
to go after the company.
Dividends and taxes-- dividends are not
considered a business expense-- we already mentioned that--
and are not tax deductible.
Interest is though.
Dividends received by individuals are taxed.
Right-- that means it's taxed twice.
The profit from the firm is taxed.
And then when these poor individuals--
they get their dividends and they are taxed again.
Now, there's some exemptions in IRS law--
go look this up if you want the exact details.
But guess what?
Dividends received by corporations
have a minimum 70% exclusion from taxable income.
Now, what does this mean?
A corporation owns another corporation.
So it's as if they're really part of that company.
When you get up to 100%--
so you completely own this other company,
IRS says, yeah, yeah, you own the company.
You're not going to get taxed.
All right, next topic-- preferred stock.
Now, preferred stock is just a different contract, right?
And what does the word preferred mean?
We like this one better, right?
It means during bankruptcy, if you have preferred stock,
you are in front of common stockholders
in terms of getting the remaining
assets during liquidation.
It also means that your dividends are paid
before common stockholders.
So if you have a preferred stock contract it means you get paid.
If anything's left over, then the common stockholders
get paid.
Dividends-- there is a stated dividend.
Now, that's just a fancy way--
when you have a bond contract or a debt contract it says,
we're going to pay you 10%.
Well here, they call it stated dividend.
But it's the exact same amount each time.
It sounds like getting close to interest or debt.
Nevertheless, they've classified it as a stock and a dividend.
So they call it stated dividend.
And this must be paid before dividends can
be paid to common stockholders.
Still, not a liability.
Most preferred dividends are cumulative.
What does cumulative mean?
It just means to build up over time.
It means if you miss a payment of stated dividend,
on the books they remember that.
So next time they go to pay, you get
the current one and the past, missed stated dividend.
That's called arrearage.
Preferred stock generally does not carry voting rights.
Oh, right-- so now this is even sounding more like debt.
And in fact, what is debt and stock?
It's all just a contract, right?
So a company wrote this contract up.
And it sounds pretty much like debt.
Stated dividend-- so that means the same amount each time.
They get paid before the common stockholders, and no voting
rights.
Also, in liquidation, they are paid
what's called the stated value.
Up here we said stated dividend.
That just means in the contract it says,
we're going to give you $5 each time, once a year, right?
Here, there's a stated value for the actual stock.
So if, in liquidation--
liquidation, they just go look at the contract.
It says stated value.
And that's how much they pay the stockholder.
So man, it sounds exactly like debt.
And in accounting, the old issue has always been,
do we recorded it as debt or equity?
So really, conceptually, it sounds like half and half.
To me, it sounds more like debt than anything.
That's a little bit about preferred stock
and common stock.
And we have one more video.
We'll talk a little bit about the financial markets,
before we get into our videos using Excel and looking
at the math of how to value stocks.
And in the videos about valuing stocks--
think about this.
What's a dividend?
It's cash.
And when you buy a stock, you hope to get cash in the future.
So just think about that.
Is there a way we've already learned in this class
to actually value the stock?
All right, we'll leave you with that tidbit.
And we'll see you next video.