Dividend Stock Investing Guide

Top Dividend Stocks

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Onetime nonrecurring gains due to dividends received or trading gains

CFO technically includes two cash flow items that analysts often re-classify into cash flow from financing (CFF) (1) dividends received from investments and (2) gains losses from trading securities (investments that are bought and sold for short-term profits). If you find that CFO is boosted significantly by one or both of these items, they are worth examination. Perhaps the inflows are sustainable. On the other hand, dividends received are often not due to the company's core operating business and may not be predictable. And gains from trading securities are even less sustainable. They are notoriously volatile and should generally be removed from CFO (unless, of course, they are core to operations, as with an investment firm). Further, trading gains can be manipulated management can easily sell tradable securities for a gain prior to year-end, thus boosting CFO.

Forward Contracts On A Security That Provides A Known Dividend Yield

As will be explained in later sections, both currencies and stock indices can be regarded as securities that provide known dividend yields. In this section, we provide a general analysis of forward contracts on such securities. A known dividend yield means that the income when expressed as a percentage of the security price is known. We will assume that the dividend yield is paid continuously at an annual rate q. To illustrate what this means, suppose that q 0.05 so that the dividend yield is 5 percent per annum. When the security price is 10, dividends in the next small interval of time are paid at the rate of 50 cents per annum when the security price is 100, dividends in the next small interval of time are paid at the rate of 5 per annum and so on. Note that if the dividend yield rate varies during the life of the forward contract, Equation (3.10) is still correct with q equal to the average dividend yield rate. Consider a 6-month forward contract on a security that is expected to...

Exerciseready American Calls On Dividend Paying Stocks

Section 1.4 showed that it is never optimal to exercise early a call option on a non-dividend paying stock and as a result prices of American and European call options are the same for non-dividend paying stocks. However, it can be optimal to exercise early an American call option on a dividend paying stock. For that reason the price of an American call option on a dividend paying stock can differ from its European counterpart. To see this consider an American call option on the French pharmaceutical company Sanofi-Aventis with a strike price of 50 and a maturity of 3 months. Sanofi is currently trading at 80 and the stock is due to go ex-dividend11 tomorrow with a payable dividend of 1.50. Since this option is clearly far in the money the time value12 of this option is very little, which means that this option has a very high delta. Since the stock will go ex-dividend tomorrow one can expect the share price to drop by 1.50 and as a result the intrinsic value of the option to go from...

Applicability of the Dividend Discount Model

While many analysts have abandoned the dividend discount model, arguing that its focus on dividends alone is too narrow, the model does have its proponents. In fact, many in the Ben Graham school of value investing swear by the dividend discount model and its soundness. In this section, we will begin by considering the advantages of the dividend discount model and then follow up by looking at its limitations. We will end the section by looking at scenarios where the dividend discount model is most applicable. The dividend discount model's primary attraction is its simplicity and its intuitive logic. After all, dividends represent the only cash flow from the firm that is tangible to investors. Estimates of free cash flows to equity and the firm remain estimates and conservative investors can reasonably argue that they cannot lay claim on these cash flows. Thus, Microsoft may have large free cash flows to equity but an investor in Microsoft cannot demand a share of Microsoft's cash...

Changed Dividend Policy

A common stock dividend is a distribution of a portion of the assets of a corporation to its common stock shareholders. The amount received by an investor is proportional to the number of shares held. In most cases, cash is distributed. On rare occasions, a publicly held corporation may pay a dividend in a form other than cash. For example, a corporation may distribute, as a dividend, the shares it owns in another corporation. The Owens-Illinois Corporation did this as a means of complying with a court decree which required it to reduce its holdings of common stock in Owens-Corning Fiberglas. When a corporation pays a dividend, its assets are reduced by the amount of the dividend. In publicly traded stock, the price per share declines by approximately the amount of the dividend on the day that the stock goes ex-dividend. The owner of the stock, at the moment the stock goes ex-dividend, will receive the dividend. Because of other factors affecting the stock price, as well as tax...

Dividend Payout Ratio

The dividend payout ratio is total common dividends divided by income available to common shareholders. We can better understand the company's financial situation by analyzing the payout ratio in relation to the investment rate. If the company has a high dividend payout ratio and an investment rate greater than one, then it must be borrowing money to fund a negative free cash flow, to pay interest, and to pay dividends. We might be concerned about how sustainable this is. On the other hand, a company with positive free cash flow and low dividend payout is probably paying down debt. If sustained, this company might be passing up the tax benefits of debt.

Reasons for Paying Dividends

There have been two rules of thumb with respect to dividend policy of publicly held corporations first, that it is necessary for the firm to pay cash dividends to common stockholders and second, the dividends through time must increase. It is far from obvious that the above policies are optimum from the point of view of maximizing the well-being of stockholders. In this chapter we consider the effect of different dividend policies on the well-being of the common stockholders. Private equity capital offers complete flexibility regarding dividend policy. The primary reasons for paying dividends are If investors do not pay taxes (or have a very low tax rate), then cash dividends are a sensible way of a corporation's distributing cash. consumption purposes. While such investors could sell a portion of their holdings, this latter transaction has relatively high transaction costs compared to cashing a dividend check. The presence of investors desiring cash for consumption makes it difficult...

Reasons for Not Paying Dividends

The motivations for not paying cash dividends are There are better forms of distribution than cash dividends, given tax considerations. There are transaction costs with an investor receiving cash and then having to reinvest. The firm has transaction costs if it needs to raise an equivalent amount of cash to substitute for the dividend. Retention may be better than a dividend when the firm has good investments and the tax law favors retention compared to cash dividends.

The Earnings Only Alternative Stock Dividends or Interest Only

A 1972 retiree enjoyed stock dividend yields above 4 percent (and as high as 6 percent) until 1985. After that time, yields moved precipitously downward to about 3 percent by 1994 and continued to decrease to about 1 percent in the year 2000.9 As a result of more favorable taxation of dividends in the tax legislation of 2003, dividends from common stocks are tending to increase.

Concept Checkers Dividend Policy

B. borrow money to maintain the dividend payout schedule. B. The clientele effect suggests that firms should follow a stable dividend policy. C. The tax preference theory suggests that a firm can increase its stock price by increasing its dividend payout ratio. dividend payout ratios. 3. Which of the following statements about dividend policy is TRUE B. Current tax law encourages companies to pay large dividends to their shareholders. C. If a company has an established clientele that prefers large dividends, the company is unlikely to adopt a residual dividend policy. D. If a firm follows a residual dividend policy, its dividend payout will tend to rise whenever the firms investment opportunities improve. 4. Which of the following statements about dividend policy is TRUE A. A residual dividend policy is an effective way to stabilize dividend payout. B. The signaling hypothesis is based on the concept that investors prefer current dividends over capital gains. C. If Congress lowers the...

Dividend Discount Models

In the strictest sense, the only cash flow you receive from a firm when you buy publicly traded stock is the dividend. The simplest model for valuing equity is the dividend discount model -- the value of a stock is the present value of expected dividends on it. While many analysts have turned away from the dividend discount model and viewed it as outmoded, much of the intuition that drives discounted cash flow valuation is embedded in the model. In fact, there are specific companies where the dividend discount model remains a useful took for estimating value. This chapter explores the general model as well as specific versions of it tailored for different assumptions about future growth. It also examines issues in using the dividend discount model and the results of studies that have looked at its efficacy.

Issues in using the Dividend Discount Model

The dividend discount model's primary attraction is its simplicity and its intuitive logic. There are many analysts, however, who view its results with suspicion because of limitations that they perceive it to possess. The model, they claim, is not really useful in valuation, except for a limited number of stable, high-dividend paying stocks. This section examines some of the areas where the dividend discount model is perceived to fall short. (a) Valuing non-dividend paying or low dividend paying stocks The conventional wisdom is that the dividend discount model cannot be used to value a stock that pays low or no dividends. It is wrong. If the dividend payout ratio is adjusted to reflect changes in the expected growth rate, a reasonable value can be obtained even for non-dividend paying firms. Thus, a high-growth firm, paying no dividends currently, can still be valued based upon dividends that it is expected to pay out when the growth rate declines. If the payout ratio is not...

Tests of the Dividend Discount Model

The ultimate test of a model lies in how well it works at identifying undervalued and overvalued stocks. The dividend discount model has been tested and the results indicate that it does, in the long term, provide for excess returns. It is unclear, however, whether this is because the model is good at finding undervalued stocks or because it proxies for well-know empirical irregularities in returns relating to price-earnings ratios and dividend yields. A Simple Test of the Dividend Discount model A simple study of the dividend discount model was conducted by Sorensen and Williamson, where they valued 150 stocks from the S& P 400 in December 1980, using the dividend discount model. They used the difference between the market price at that time and the model value to form five portfolios based upon the degree of under or over valuation. They made fairly broad assumptions in using the dividend discount model. The returns on these five portfolios were estimated for the following two...

LOS 50g Summarize the factors affecting dividend payout policy

A company's dividend payout policy is the approach a company follows in determining the amount and timing ot dividend payments to shareholders. Six primary factors affect a company's dividend payout policy Signaling effect. Unexpected changes in a company's dividend policy are often viewed by investors as a signal from management about projections of the firm's future performance. In other words, stockholders perceive changes in dividend policy as conveying important information about the firm. Taxation of dividends. Investors are concerned about after-tax returns. Investment income is taxed by most countries however, the ways that dividends are taxed vary widely from country to country. The method and amount of tax applied to a dividend payment can have a significant impact on a firm's dividend policy. * Tax considerations. High-tax-bracket investors (like some individuals) prefer low dividend payouts, and low-tax-bracket investors (like corporations and pension funds) prefer high...

The Safety Of Interest And Preferred Dividends

In analyzing an investment grade bond, the coverage of Fixed Charges is the main criterion. In the case of a high grade preferred stock, the comparable test is the coverage of Fixed Charges plus Preferred Dividends. It is best to take a ten year average, but if a shorter period is used then completely abnormal years like 1931 and 1932 might justifiably be eliminated. The following minimum over-all coverage is recommended for investment bonds and preferred stocks. (These figures are higher than are ordinarily prescribed, but there is no harm in being over-conservative in choosing investments.)

LOS 50a Review cash dividends stock dividends stock splits and reverse stock splits and calculate and discuss their

Cash dividends, as the name implies, are payments made to shareholders in cash. They come in three forms * Regular dividends occur when a company pays out a portion of profits on a consistent schedule (e.g., quarterly). A long-term record of stable or increasing dividends is widely viewed by investors as a sign of a company's financial stability. No matter which form cash dividends take, their net effect is to transfer cash from the company to its shareholders. The payment ot a cash dividend reduces a company's assets and the market value of its equity. This means that immediately after a dividend is paid, the price of the stock should drop by the amount ot the dividend. For example, if a company's stock price is 25 per share and the company pays 1 per share as a dividend, the price of the stock should immediately drop to 24 per share to account tor the lower asset and equity values ot the firm. Stock dividends are dividends paid out in new shares ot stock rather than cash. In this...

FCFE Potential Dividend Discount Models

The free cash flow to equity model does not represent a radical departure from the traditional dividend discount model. In fact, one way to describe a free cash flow to equity model is that it represents a model where we discount potential dividends rather than actual dividends. Consequently, the three versions of the FCFE valuation model presented in this section are simple variants on the dividend discount model, with one significant change - free cashflows to equity replace dividends in the models. How does discounting free cashflows to equity compare with the modified dividend discount model, where stock buybacks are added back to dividends and discounted You can consider stock buybacks to be the return of excess cash accumulated largely as a consequence of not paying out their FCFE as dividends. Thus, FCFE represent a smoothed out measure of what companies can return to their stockholders over time in the form of dividends and stock buybacks. As with the dividend discount model,...

Variations on the Dividend Discount Model

Since projections of dollar dividends cannot be made through infinity, several versions of the dividend discount model have been developed based upon different assumptions about future growth. We will begin with the simplest - a model designed to value stock in a stable-growth firm that pays out what it can afford to in dividends and then look at how the model can be adapted to value companies in high growth that may be paying little or no dividends. The Gordon growth model relates the value of a stock to its expected dividends in the next time period, the cost of equity and the expected growth rate in dividends.

Deciphering dividend dates

If you own a stock the day before the ex-dividend date, then you receive the dividend. If you buy it on the ex-dividend date, you don't receive the dividend. For trading purposes, focus on the day before the ex-dividend date, because that's when you want to own the stock to receive the dividend. The record date, two trading days after the ex-dividend date, which is the date on which the owners of a stock are identified as eligible to receive a dividend For an example, look at the following dates for the second dividend paid by IBM in 2007

FCFE Valuation versus Dividend Discount Model Valuation

The discounted cash flow model that uses FCFE can be viewed as an alternative to the dividend discount model. Since the two approaches sometimes provide different estimates of value, it is worth examining when they provide similar estimates of value, when they provide different estimates of value and what the difference tells us about the firm. There are two conditions under which the value from using the FCFE in discounted cashflow valuation will be the same as the value obtained from using the dividend discount model. The first is the obvious one, where the dividends are equal to the FCFE. The second condition is more subtle, where the FCFE is greater than dividends, but the excess cash (FCFE - Dividends) is invested in projects with net present value of zero. (For instance, investing in financial assets which are fairly priced should yield a net present value of zero.) There are several cases where the two models will provide different estimates of value. First, when the FCFE is...

Extensions of the Dividend Discount Model

One reason for the fall of the dividend discount model from favor has been the increased used of stock buybacks as a way of returning cash to stockholders. A simple response to this trend is to expand the definition of dividends to include stock buybacks and to value stocks based on this composite number. In this section, we will consider the possibilities and limitations of this expanded dividend discount model and also examine whether the dividend discount model can be used to value entire markets or sectors. An Expanded Dividend Discount Model What are the implications for the dividend discount model Focusing strictly on dividends paid as the only cash returned to stockholders exposes us to the risk that we might be missing significant cash returned to stockholders in the form of stock buybacks. The simplest way to incorporate stock buybacks into a dividend discount model is to add them on to the dividends and compute a modified payout ratio Modified dividend payout ratio ---...

Dividend dates

The usefulness of dividends as a way of making a profit on the market comes and goes. Sometimes investors are focused on buying stocks for their dividend yields, and other times price appreciation is a much more lucrative endeavor. Like all market cycles, dividend paying stocks fall in and out of favor, and the focus on dividends waxes and wanes. For now, though, it's very possible that some stocks that pay higher than average dividend yields trade in a certain pattern around their dividend dates. If the dates on which dividends are paid are noted on your charts, you may very well be able to recognize a pattern that surrounds these dates and buy or sell to profit from it.

Dividend Policy

The expectation of receiving dividends (broadly defined as any distribution of value) ultimately determines the market value of the common stock. By declaring a dividend, the board of directors is not only turning over some of the assets of the corporation to its stockholders, but it may be influencing the expectations stockholders have about the future dividends they can expect from the corporation. If expectations are affected, the dividend decision and the underlying dividend policy will have a short term impact on the value the market places on the common stock of the corporation. Many financial experts believe that a highly stable but growing dividend is advantageous to a company. The most common reason stated for this belief is that stockholders prefer a steady income from their investments. There is at least one other important reason for thinking that a highly variable dividend rate may not be in the best interest of a company. In the long run, the value of a share of stock...

Cash Dividends

Dividend irrelevance in the absence of taxes and transaction costs is a fundamental tenet of financial theory. Tax-code discrimination against dividend income should, if anything, punish high-yield stocks. Finally, the clientele effect predicts that, if investors exhibited preference for dividends over capital gains, supply of dividends by corporations would materialize so as to eliminate risk-adjusted differentials in expected returns. Nevertheless, high dividends seem to endow stocks with a price premium. Preference for cash dividends can be justified by mental accounts, since dividends increase current income at the expense of the higher self control equity account. As evidence for such bias in the population, Lease, Lewellen, and Schlarbaum (1976) compiled Table 19.1, which shows that older and retired investors, those with the most funds to invest, value dividends more highly and concentrate their (better diversified ) portfolios in high income securities.

Contingent Claim Valuation

This is not to suggest that using real options models is an unalloyed good. Using real options arguments to justify paying premiums on discounted cash flow valuations, when the options argument does not hold, can result in overpayment. While we do not disagree with the notion that firms can learn by observing what happens over time, this learning has value only if it has some degree of exclusivity. We will argue later in this book that it is usually inappropriate to attach an option premium to value if the learning is not exclusive and competitors can adapt their behavior as well. There are also limitations in using option pricing models to value long-term options on non-traded assets. The assumptions made about constant variance and dividend yields, which are not seriously contested for short term options, are much more difficult to defend when options have long lifetimes. When the underlying asset is not traded, the inputs for the value of the underlying asset and the variance in...

Statement of Cash Flows

Cash flow from financing (CFF) includes cash received (inflow) for the issuance of debt and equity. As expected, CFF is reduced by dividends paid (outflow). CFO by itself is a good but imperfect performance measure. Consider just one of the problems with CFO caused by the unnatural re-classification illustrated above. Notice that interest paid on debt (interest expense) is separated from dividends paid interest paid reduces CFO but dividends paid reduce CFF. Both repay suppliers of capital, but the cash flow statement separates them. As such, because dividends are not reflected in CFO, a company can boost CFO simply by issuing new stock in order to retire old debt. If all other things are equal, this equity-for-debt swap would boost CFO.

Discounted Cashflow Valuation

The dividend discount model is a specialized case of equity valuation, where the value of the equity is the present value of expected future dividends. (5) Firms in the process of restructuring Firms in the process of restructuring often sell some of their assets, acquire other assets, and change their capital structure and dividend policy. Some of them also change their ownership structure (going from publicly traded to private status) and management compensation schemes. Each of these changes makes estimating future cashflows more difficult and affects the riskiness of the firm. Using historical data for such firms can give a misleading picture of the firm's value. However, these firms can be valued, even in the light of the major changes in investment and financing policy, if future cashflows reflect the expected effects of these changes and the discount rate is adjusted to reflect the new business and financial risk in the firm.

Equity Securities Common Stock as Ownership Shares

Ownership shares in a publicly held corporation. Shareholders have voting rights and may receive dividends. Residual claim means stockholders are the last in line of all those who have a claim on the assets and income of the corporation. In a liquidation of the firm's assets, the shareholders have claim to what is left after paying all other claimants, such as the tax authorities, employees, suppliers, bondholders, and other creditors. In a going concern, shareholders have claim to the part of operating income left after interest and income taxes have been paid. Management either can pay this residual as cash dividends to shareholders or reinvest it in the business to increase the value of the shares.

Measuring Financing

When a company issues preferred stock, it generally creates an obligation to pay a fixed dividend on the stock. Accounting rules have conventionally not viewed preferred stock as debt because the failure to meet preferred dividends does not result in bankruptcy. At the same time, the fact the preferred dividends are cumulative makes them more onerous than common equity. Thus, preferred stock is viewed in accounting as a hybrid security, sharing some characteristics with equity and some with debt. The accounting measure of equity is a historical cost measure. The value of equity shown on the balance sheet reflects the original proceeds received by the firm when it issued the equity, augmented by any earnings made since (or reduced by losses, if any) and reduced by any dividends paid out during the period. While these three items go into what we can call the book value of equity, a few other items also end up in this estimate. 1. When companies buy back stock for short periods, with the...

High Current Returnspleasures And Implications

There are certain distinct advantages to owning higher-yield stocks such as REITs. One is that it is at the shareholder's, rather than the management's, discretion to decide what to do with one's portion of the company's operating income. As REITs use most of their free cash flow to pay substantial cash dividends, you can choose to plow the money back into the REIT (albeit on an after-tax basis in taxable accounts), invest the funds somewhere else altogether, or blow it on a trip to Hawaii. Shareholders in companies like Intel, which pay little or nothing in dividends, have no such choice. Essentially, all of their share of net income is reinvested for them by management.

The importance of the market data

So when you apply a system on a 40-year stock price series you really need to wonder what you are trading. This is the major drawback in relation to which other difficulties -such as the dividend policy - can be easily dealt with. Obviously the gap due to dividend payment must be taken into consideration and price series accordingly rectified, a task that is performed, more or less promptly, by every serious data vendor.

A buyandhold policy is not a static strategy

11 Schiller, Robert (2000), Irrational Exuberance, Princeton, NJ Princeton University Press. It is widely accepted that the value of any stock or stock index should be the present value of expected future dividends. Note, that the assumption of constant dividends growth assumed by the Dividend Valuation Model is generally considered reasonable for an index of large, mature firms such as the S& P 500. But for individual stocks such as stocks held in a buy-and-hold policy, this assumption is considered by many quite naive.

Stocks of REITs and Homebuilders

Long after the general stock market downturn of early 2000, the stocks of REITs and homebuilders continued to register positive total returns of 10 to 25 percent a year. Also, unlike the stocks of most companies, REIT stocks typically pay cash dividends of 6 to 9 percent a year.

Reits Versus Preferred Stocks

The problem here is, as with bonds, what you see is what you get pure yield and very little else. While the high dividends are enticing, preferred stocks, unlike REITs and common stocks, offer little in the way of price-appreciation potential or hedge against inflation. And their prices, like bonds', are very interest-rate sensitive.

Semistrong Form Efficiency

This second level of the efficient market hypothesis encompasses weak form efficiency, and adds the additional requirement that all expectations about a firm are incorporated into the stock price. There is no reason why an investor who thought an interest rate hike was an inevitability would wait until the formal announcement to trade on the information. In previous sections we have implicitly used semi-strong form efficiency in our pricing formulas by pricing expected earnings or expected dividends.

What did you tell her you were going to do with the money

I did tell her that I was going to invest it, but I told her that I was going to invest it in a conservative dividend play that would give us a greater return than the rate we had to pay on the home-equity loan. That was my intention. But once I had the money I thought, I'm not going to put this into some boring dividend play to make a few dollars on the spread between the dividend income and my loan rate.

From Firm to Equity Cash Flows

While cash flows to the firm measure cash flows to all claimholders in the business, cash flows to equity focus only on cashflows received by equity investors in that business. Consequently, they require estimates of cash flows to lenders and other non-equity claimholders in the business. In the narrowest sense, the only cash flow that equity investors receive from the firm is dividends and we can build our valuations around dividends paid. As we will see in this section, though, firms do not always pay out what they can afford to in dividends. A more realistic estimate of equity value may require us to estimate the potential dividends, i.e, the cash flow that could have been paid out as a dividend.

Contemporary Value Techniques

The first category is the low P E manager, who buys stocks with multiples below the market average. This manager normally owns out-of-favor stocks. The second is the high-yield investor, who buys stocks with higher-than-market dividend yields and future dividend potential. The third category buys low market valuation relative to book value, which often leads him to depressed cyclicals. This manager is sometimes considered the most contrarian, as he or she will buy companies with no current earnings. The last group focuses on the private or going concern value, measuring underlying assets or cash flow much the way takeover specialists do. Though the tributaries can diverge widely, all spring from methods described above.

Earnings Versus Dividends Versus Cash Flows Present Value Calculations

The risk-adjusted present value of future dividends is a theoretically correct method of computing the value of a firm's stock equity, if dividends are defined to include all cash flowing from the firm to the stockholders, whatever the form of the flow. Despite the correctness of using dividends, there are complexities. First, the amount of dividends is a derived measure. It is derived from the projections of future cash flows or earnings of the firm. Second, in a situation where there are no cash dividends it is very difficult (but not impossible) to estimate the future dividends. Third, an acquirer tends to be more comfortable with the use of the target firm's cash flows or earnings. Where the target firm is

Characteristics of Common Stock

Residual claim means that stockholders are the last in line of all those who have a claim on the assets and income of the corporation. In a liquidation of the firm's assets the shareholders have a claim to what is left after all other claimants such as the tax authorities, employees, suppliers, bondholders, and other creditors have been paid. For a firm not in liquidation, shareholders have claim to the part of operating income left over after interest and taxes have been paid. Management can either pay this residual as cash dividends to shareholders or reinvest it in the business to increase the value of the shares.

Stock Market Listings

To interpret the information provided for each traded stock, consider the listing for Home Depot. The first two columns provide the highest and lowest price at which the stock has traded in the last 52 weeks, 70 and 39.38, respectively. The .16 figure means that the last quarter's dividend was .04 per share, which is consistent with annual dividend payments of .04 X 4 .16. This value corresponds to a dividend yield of .3 , meaning that the dividend paid per dollar of each share is .003. That is, Home Depot stock is selling at 50.63 (the last recorded or close price in the next-to-last column), so that the dividend yield is .16 50.63 .0032 .32 , or .3 rounded to one decimal place. The stock listings show that dividend yields vary widely among firms. It is important to recognize that high-dividend-yield stocks are not necessarily better investments than low-yield stocks. Total return to an investor comes from dividends and capital gains, or appreciation in the value of the stock....

Who Lends Securities For Short Selling

The availability of borrowable securities depends on their owners and not on the hedge fund community. The incentive to lend is given by the fact that the shareholder gets a compensation, which for shares is typically equal to an annual rate ranging between 1 and 5 . Share borrowers also agree to refund any dividends paid out by the stock during the lending period to the original owner. So the shareholder enhances the return on his shares, because in addition to the dividend yield, he gets also a lending fee, that is, a compensation for lending the shares. This is an attractive incentive for institutional investors, who have large equity portfolios. In addition, share lenders have the right to call in the shares at any

Example 612 FRM Exam 1999Question 55Capital Markets

If the Garman-Kohlhagen formula is used for valuing options on a dividend-paying stock, then to be consistent with its assumptions, upon receipt of the dividend, the dividend should be d) Placed into an interest bearing account, paying interest equal to the dividend yield of the stock

Discounted Dividend Model

Owning a share gives the right to receive a stream of future dividends. Thus, directly estimating the present value (V0) of a share involves estimating the present value of future dividends. We will assume that dividends are paid annually. If a dividend has just been paid, we obtain It might seem that equation (3.1) could give an infinite value for the share. This is mathematically possible but unrealistic. In practice, the rate of dividend growth in the long run will be lower than the required rate of return. Thus, the present values of more and more distant dividends will eventually become smaller and smaller until they can be ignored. Estimating future dividend payments is not an easy matter. The usual approach would be to estimate the company's profits and hence earnings per share, and then multiply by an estimate of the proportion of earnings paid out in dividends. All relevant available information must be taken into account and all future dividends, until such time as their...

Other Option Contracts

Because an average is less variable than an instantaneous value, such options are cheaper than regular options due to lower volatility. In fact, the price of the option can be treated like that of an ordinary option with the volatility set equal to a J3 and an adjustment to the dividend yield.3 As a result of the averaging process, such

Standard Poors Indexes

The S& P 500 is computed by calculating the total market value of the 500 firms in the index and the total market value of those firms on the previous day of trading. The percentage increase in the total market value from one day to the next represents the increase in the index. The rate of return of the index equals the rate of return that would be earned by an investor holding a portfolio of all 500 firms in the index in proportion to their market values, except that the index does not reflect cash dividends paid by those firms.

Other Contrarian Strategies

In addition to looking at low P E ratios as a contrarian strategy, David also selects stocks using price-to-cash flow (adding depreciation and other noncash charges to after-tax earnings) and price-to-book value (the value of all common stock after deducting all depreciation and liabilities). The studies comparing low P Es and high P Es were remarkably similar to the studies of the low price-to-book and low price-to-cash flow strategy. All three value strategies handily beat the market and sharply outperform the best stocks in each case, he says. These two additional strategies also offer significantly higher dividends than the overall market, and more than triple the dividend of the stocks with the higher ratios. The fourth strategy, price-to-dividend yield, is much more controversial among traditional analysts. That's because high-dividend-paying stocks are associated with nongrowth industries such as utilities. Investors in utility stocks are seeking current income at the expense...

Futures On Commodities

If the storage costs incurred at any time are proportional to the price of the commodity, they can be regarded as providing a negative dividend yield. In this case, from Equation (3.10), We might try to take advantage of this using a strategy analogous to that for a forward contract on a non-dividend-paying stock when the forward price is too low. However, this would involve shorting the commodity in such a way that the storage costs are paid to the person with the short position. This is not usually possible.

Bank Of North America

December 31, 1781, the Bank of North America was chartered with a capital of 400,000, It took its origin in a union of citizens of Philadelphia, formed in the preceding year, to supply the army with rations. They were allowed to form a bank, and, as it seems, issue notes to buy the articles required. Congress ordered bills drawn on American ministers abroad to be deposited in the bank as a guarantee of payment. 70,000 in specie were subscribed in 1782 by individuals, and the remainder by the government out of the proceeds of a foreign loan. It issued convertible notes, redeemable in Spanish dollars but the people were slow to take them. According to the story given by Gouge, the Bank was not over strong, and tried to keep up its credit by parading and handling over its stock of silver. However, it made large dividends, and was attacked by a rival which it was obliged to absorb, 3

Evaluating Financial Management Financial Leverage

In determining the financial soundness of a company one must ascertain whether a company's debt policy is prudent. Just as shareholders in companies with too much debt have one set of problems those in companies with too little have another set viz. free cash flow problem. In those companies with substantial free cash flow and limited growth opportunities, shareholders would be better off by receiving higher dividends funded with debt.

The Three Faces ofEMH

Petition between sophisticated and knowledgeable investors keeps stock prices about where they should be. This happens because all facts that determine stock prices are analyzed by large numbers of interested investors. New information, such as a change in a company's earnings outlook or a dividend cut, is quickly digested and immediately reflected in the stock price. Like it or not, competition by so many investors, all seeking hidden values, makes stock prices reflect the best estimates of their real worth. Prices may not always be right, but they are unbiased, so if they are wrong, they are just as likely to be too high as too low.

Why Audited Statements Do Not Tell the Whole Story

The solution In evaluating working capital, you also need to track total capitalization and to monitor the company's long-term debt (bonds and notes). If you discover that a corporation is creating effective working capital by increasing long-term debt, it is usually a highly negative sign for several reasons. First, the practice creates an artificially positive-looking outcome but it is deceptive. Second, as long-term debt is increased, it places an ever-increasing burden on future cash flow and robs stockholders of future dividends. Because the corporation will have to repay the long-term debt and make interest payments, the higher that debt and the less profits there are to continue funding working capital or to declare dividends.

Taking a look at performance

One final attribute of REITs we want to highlight is the fairly substantial dividends that REITs usually pay. Because these dividends are generally fully taxable (and thus not subject to the lower stock dividend tax rate), you should generally avoid holding REITs outside of retirement accounts if you're in a high tax bracket (for instance, during your working years). In case you care, and you may well not, the reason for the high dividends is the legal requirement in REIT charters that they have to distribute 95 percent of their income. In other words, REITs can legally only retain a maximum of 5 percent of their net income they must distribute everything else to the shareholders.

The Defensive Investor and Common Stocks

The first was that they had offered a considerable degree of protection against the erosion of the investor's dollar caused by inflation, whereas bonds offered no protection at all. The second advantage of common stocks lay in their higher average return to investors over the years. This was produced both by an average dividend income exceeding the yield on good bonds and by an underlying tendency for market value to increase over the years in consequence of the reinvestment of undistributed profits. While these two advantages have been of major importance and have given common stocks a far better record than bonds over the long-term past we have consistently warned that these benefits could be lost by the stock buyer if he pays too high a price for his shares. This was clearly the case in 1929, and it took 25 years for the market level to climb back to the ledge from which it had abysmally fallen in 1929-1932.* Since 1957 common stocks have once again, through their...

Stable Businesses with no competition

For several decades, utility stocks (phone, water and power companies) were prized by risk averse investors for their steady earnings and high dividends. In fact, these firms were able to afford to pay out the high dividends that they did because their earnings were so predictable. The reasons for the stable earnings were not difficult to uncover. These stocks were regulated monopolies that provided basic and necessary services. The fact that their products and services were non-discretionary insulated them from overall economic conditions and the absence of competition gave them secure revenues. In return for the absence of competition, these firms gave up pricing power to the regulatory authorities.

Determinants of Option Value

The final two inputs that affect the value of the call and put options are the riskless interest rate and the expected dividends on the underlying asset. The buyers of call and put options usually pay the price of the option up front, and wait for the expiration day to exercise. There is a present value effect associated with the fact that the promise to buy an asset for 1 million in 10 years is less onerous than paying it now. Thus, higher interest rates will generally increase the value of call options (by reducing the present value of the price on exercise) and decrease the value of put options (by decreasing the present value ofthe price received on exercise). The expected dividends paid by assets make them less valuable thus, the call option on a stock that does not pay a dividend should be worth more

The Most Dividendsensitive Options

3.2 it was shown that the price of an option on a dividend paying stock can easily be calculated by putting into the Black-Scholes formula a stock price St equal to the current stock price minus the present value of the dividends. The delta measures the sensitivity of an option price to a change in the underlying St. From this it is clear that an option with a large delta in absolute terms will be very sensitive to dividend changes. This means that far in-the-money options as well as synthetics have large dividend exposures.

The Nifty Fifty Crash 19721982

Indeed, it is this aspect of corporate performance that makes equities cornerstones in the portfolio of retirees Their portfolio's value and their dividend income are expected to stay ahead of inflation. My employer was a major Canadian life insurer, which owned a remarkably large position in IBM. The company had owned these shares since the Depression. It had bought and held them because of their high dividend yield. The imbedded capital gains were, of course, enormous, and each time the company had lightened up in the past, it regretted the sale, since IBM just kept reaching new peaks.

Price Trends of Income Stocks

The income stocks, most of which are utilities, were in a persistent decline for about a decade because of continued inflation. Compared with the quick, spectacular results that are possible in the well-timed purchase of carefully selected superperformance stocks, those stocks which triple or more in price in two years or less, it is interesting to note what has occurred to income stocks selected because of their large dividends. Chart 7 shows the Dow Jones utility average, which is calculated from the prices of fifteen large electric and gas utility companies. Inflation and the resulting high yields from bonds and high interest rates from bank deposits have had a continuous depressing effect on the prices of most utilities and other common stocks purchased because of their dividends. The only way that income stocks can keep the stock price up is by raising the dividend to a level that is competitive with bond yields and interest from bank deposits. Most other income stocks, including...

Equity Discounted Cash Flow Models

The first set of models examined take a strict view of equity cash flows and consider only dividends to be cashflows to equity. These dividend discount models represent the oldest variant of discounted cashflow models. While abandoned by many analysts as old-fashioned, we will argue that they are still useful in a wide range of circumstances. We then consider broader definitions of cash flows to equity, by first including stock buybacks in cashflows to equity and by then expanding out analysis to cover potential dividends or free cash flows to equity. We will close the chapter by examining why the different approaches may yield different values for equity per share.

Determining Expected Return

To see how a stock's expected return is computed, let's look once again at Universal Office Furnishings. Using 2002-2004 data from Table 8.3, along with the stock's current price of 41.58, we can determine Universal's expected return. To do so, we find the discount rate that equates the future stream of benefits (i.e., the future annual dividends and future price of the stock) to the stock's current market price. In other words, find the discount rate that produces a present value of future benefits equal to the price of the stock, and you have the IRR, or expected return on that stock. Here's how it works Using the Universal example, we know that the stock is expected to pay per-share dividends of 0.18, 0.24, and 0.28 over the next 3 years. At the end of that time, we hope to sell the stock for 93.20. Given that the stock is currently trading at 41.58, we're looking for the discount rate that will produce a present value (of the future annual dividends and stock price) equal to...

Varieties Of Mutual Funds

A mix of the income equity and growth funds, these funds strive to invest in firms that will show positive growth and income (dividends) rates in the future, as well as providing some good dividend income in the present. The risk level for these funds tends to be moderate because of the balance between the growth and income factors. Option-Income Funds. These funds tend to invest in the common stock of firms that pay reasonable current dividends. However, they also try to increase the income to investors by writing call options on the stock they hold.

American Versus European Options Variables Relating To Early Exercise

While early exercise is not optimal generally, there are at least two exceptions to this rule. One is a case where the underlying asset pays large dividends, thus reducing the value of the asset, and any call options on that asset. In this case, call options may be exercised just before an ex-dividend date if the time premium on the options is less than the expected decline in asset value as a consequence of the dividend payment. The other exception arises when an investor holds both the underlying asset and deep in-the-money puts on that asset at a time when interest rates are high. In this case, the time premium on the put may be less than the potential gain from exercising the put early and earning interest on the exercise price.

Risk Characteristics of Investments

Value stocks can be characterized as relatively well-established, high dividend-paying companies with low price-to-earnings and price-to-book ratios. Essentially, they are diamonds in the rough that typically have undervalued assets and earnings potential. Classic value stocks include oil companies like ExxonMobil and banks such as Bank of America or J.P. Morgan Chase.

Sticking with the Plan Investments

The rationale for its success is that easier money and lower interest rates sooner or later help stimulate the economy. Thus, txpanding business means higher profits greater profits imply higher dividends, which in turn mean higher stock prices. After a point, rising interest rates kill the economy. This in turn results in a bear market in equities.

Equity Markets

Preferred stocks differ from common stock because they promise to pay a specific stream of dividends. So, they behave like a perpetual bond, or consol. Unlike bonds, however, failure to pay these dividends does not result in bankruptcy. Instead, the corporation cannot pay dividends to common stock holders until the preferred dividends have been paid out. In other words, preferred stocks are junior to bonds, but senior to common stocks. With cumulative preferred dividends, all current and previously postponed dividends must be paid before any dividends on common stock shares can be paid. Preferred stocks usually have no voting rights. Unlike interest payments, preferred stocks dividends are not tax-deductible expenses. Preferred stocks, however, have an offsetting tax advantage. Corporations that receive preferred dividends only pay taxes on 30 of the amount received, which lowers their income tax burden. As a result, most preferred stocks are held by corporations. The market...

Investment Philosophy and the Valuation Of Equity

The high prices that stocks reach during bull markets, which historians often characterize as filled with undue or unwarranted optimism, are in fact often justified on the basis of the long-term record of corporate earnings and dividend growth. Unfortunately, this long perspective does not interest most players in the market. Most investors roundly ignore forecasters who analyze the long run, but do not predict the direction of the market in the short run.

The Amex stock exchange Composite Index

The American Stock Exchange introduced the AMEX Composite Index with a new ticker symbol, XAX, on January 2,1997 it replaced The AMEX Market Value Index (XAM), which, since its introduction in 1973, had been calculated on a total return basis to include the reinvestment of dividends paid by AMEX companies. The XAX is comparable with indexes reflecting only the price appreciation of their respective components. The index covers all of the common stocks listed on the AMEX, as well as warrants and American depository receipts (ADRs).8

Demand For Stocks And Equilibrium Prices

Sigma Fund is a new actively managed mutual fund that has raised 220 million to invest in the stock market. The security analysis staff of Sigma believes that neither BU nor TD will grow in the future and, therefore, each firm will pay level annual dividends for the foreseeable future. This is a useful simplifying assumption because, if a stock is expected to pay a stream of level dividends, the income derived from each share is a perpetuity. The present value of each share often called the intrinsic value of the share equals the dividend divided by the appropriate discount rate. A summary of the report of the security analysts appears in Table 7.2.

Deriving Risk Neutralized Processes

If the asset pays a dividend rate y, however, the asset process in the market measure must reflect the dividend payments as a drop in value This says that in the domestic measure, the foreign exchange rate behaves like an asset that pays a dividend yield equal to the instantaneous foreign risk-free rate.

Looking at important dates

1 Date of declaration This is the date when a company reports a quarterly dividend and the subsequent payment dates. On January 15, for example, a company may report that it is pleased to announce a quarterly dividend of 50 cents per share to shareholders of record as of February 10. That was easy. The date of declaration is really just the announcement date. If you buy the stock before, on, or after the date of declaration, it won't matter in regard to receiving the stock's quarterly dividend. The date that matters is the date of record (see that bullet later in this list). Ex-dividend date Ex-dividend means without dividend. Because it takes three days to process a stock purchase before you become an official owner of the stock, you have to qualify (that is, you have to own or buy the stock) before the three-day period. That three-day period is referred to as the ex-dividend period. When you buy stock during this short time frame, you aren't on the books of record, because the...

A When they are similar

There are two conditions under which the value from using the FCFE in discounted cashflow valuation will be the same as the value obtained from using the dividend discount model. The first is the obvious one, where the dividends are equal to the FCFE. There are firms that maintain a policy of paying out excess cash as dividends either because they have pre-committed to doing so or because they have investors who expect this policy of them. The second condition is more subtle, where the FCFE is greater than dividends, but the excess cash (FCFE - Dividends) is invested in fairly priced assets (i.e. assets that earn a fair rate of return and thus have zero net present value). For instance, investing in financial assets that are fairly priced should yield a net present value of zero. To get equivalent values from the two approaches, though, we have to keep track of accumulating cash in the dividend discount model and add it to the value of equity (as shown in illustration 5.11 at the end...

Figuring Investment Performance

A good way to measure how your mutual funds are performing on an annual basis is to calculate their total return. This accounts for any dividends and capital gains paid to shareholders, plus the change in the NAV. For example, let's assume that the XYZ International Fund began the calendar year at 32 per share. At the end of the year, the price per share was 36. They didn't distribute any dividend income, but they had a realized capital gain of 2.30. The XYZ International Fund's total return for that year would be 6.30.

Event Driven Merger Arbitrage

To understand the nature of merger arbitrage, consider a hypothetical example. Shares of Company A are trading at 20. Shares of Company B are trading at 70. You estimate that Company A will pay a quarterly dividend of .25 per share on January 15, April 15, July 15, and October 15. You estimate that Company B will pay a quarterly dividend of .50 per share on February 15, May 15, August 15, and November 15.

Understanding why these dates matter

Remember that three business days pass between the date of execution and the closing date. Three business days are also between the ex-dividend date and the date of record. This information is important to know if you want to qualify to receive an upcoming dividend. Timing is important, and if you understand these dates, you know when to purchase stock and whether you qualify for a dividend. As an example, say that you want to buy ValueNowInc (VNI) in time to qualify for the quarterly dividend of 25 cents per share. Assume that the date of record (the date by which you have to be an official owner of the stock) is February 10. You have to execute the trade (buy the stock) no later than February 7 to be assured of the dividend. If you execute the trade right on February 7, the closing date occurs three days later, on February 10 just in time for the date of record. But what if you execute the trade on February 8, a day later Well, the trade's closing date is February 11, which occurs...

The Tax Drag on Returns

20 To provide an example, the average dividend yield across all stocks in 1996 was 3.20 and the total return was 23.82 . The half dividend yield portfolio was estimated to have a dividend yield of 1.60 and a price appreciation of 22.22 for a total return of 23.82 . The double dividend yield portfolio had a dividend yield of 6.40 and a price appreciation of 17.42 for a total return of 23.82 .

Concept Checkers The Cost of Capital

A. the preferred stock dividend divided by its par value. B. the preferred stock dividend multiplied by the net market price. C. (1 - tax rate) times the preferred stock dividend divided by the net price . D. the preferred stock dividend divided by the market price net of flotation costs. 4. The expected dividend is 2.50 for a share of stock priced at 25. What is the cost of equity if the long-term growth in dividends is projected to be 8 percent 5. The expected dividend is 2.50 for a share of stock priced at 25. What is the cost of new equity if flotation costs are 10 percent and the long-term growth in dividends is projected to be 8 percent 15. A firm with a debt-to-equity ratio of 0.5 and a dividend payout ratio of 40 percent projects earnings to be 20 million. What is the retained earnings new equity break point

Firm Valuation Models

In the last two chapters, we examined two approaches to valuing the equity in the firm -- the dividend discount model and the FCFE valuation model. This chapter develops another approach to valuation where the entire firm is valued, by discounting the cumulated cashflows to all claim holders in the firm by the weighted average cost of capital (the cost of capital approach) or by adding the marginal impact of debt on value to the unlevered firm value (adjusted present value approach). We will also examine a third approach where the present value of excess returns is computed and added to the capital invested in the firm to arrive at firm value.

Return Before Expenses And Taxes

Exhibit 6.8 shows the cumulative returns to this fund. In terms of our example, the cumulative return is 38.64 assuming reinvestment of the dividends on each ex-dividend date. Because of the hypothetical beginning investment of 1000, this method of calculating a return is slightly different from that in the previous chapters, but in fact the results are the same TWR.

The Cost of Capital Approach

In the cost of capital approach, the value of the firm is obtained by discounting the free cashflow to the firm at the weighted average cost of capital. Embedded in this value are the tax benefits of debt (in the use of the after-tax cost of debt in the cost of capital) and expected additional risk associated with debt (in the form of higher costs of equity and debt at higher debt ratios). Just as with the dividend discount model and the FCFE model, the version of the model used will depend upon assumptions made about future growth. As with the dividend discount and FCFE models, the FCFF model comes in different forms, largely as the result of assumptions about how high the expected growth is and how long it is likely to continue. In this section, we will explore the variants on free cash flow to the firm models. As with the dividend discount and FCFE models, a firm that is growing at a rate that it can sustain in perpetuity - a stable growth rate - can be valued using a stable growth...

Forecasting and Following Finding the Trend

There are two ways to find the trend. By analyzing major economic factors, you can conclude that prices should go higher. Greater demand, good management, better technology, and cheaper money may all contribute to long-term growth, higher dividends, and higher share prices. Energy prices may be pushed up by greater consumption, a unified OPEC position to cut production, or supply disruption in Siberia. But basic fundamental evaluation is difficult and dependent on reliable information. The conclusion may change if new factors are introduced. Changes must be constantly monitored and weighed.

Long Term Goals as a Guiding Force

A more subtle variation of risk involves how you utilize cash. For example, when you receive option premium, where can you invest it If you hope to continue earning a rate of return you think of as a minimum in your portfolio, you want to invest cash receipts in some way. Dividends can be reinvested automatically if companies whose stock you own offer dividend reinvestment plans (DRIPs), in which partial shares of stock can be acquired automatically in place of dividend cash payments. This makes sense because it creates a compound rate of return on dividend income. However, it is not as easy to create the same automatic compound returns when you sell options. Some choices include the following. Place funds received for selling options in well-selected mutual funds. Select reinvestment of all income so that your money continues earning compound rates. For example, you can invest option premium received from covered call writing in odd-lot shares of the same company this creates a...

Equity Market Neutral Dividend Capture

Stock prices reflect the timing and magnitude of dividend payments (among other factors). Corporations announce a dividend payment to be paid to all holders on a particular future date (the ex-dividend date) payable a short time later (the dividend payment date). Prices of stocks move down on the ex-dividend date because buyers of the stock will not receive the announced dividend and sellers of the stock will nevertheless keep the dividend. Pending orders on most stock exchanges are lowered by the amount of the dividend on the ex-dividend date. However, stocks generally decline on the ex-dividend date by less than the amount of the dividend. If all investors paid tax at the same rate, the decline in price should on average equal the after-tax amount of any announced dividend. In practice, investors pay many different tax rates, ranging from zero for pension funds, foundations, and endowments to the maximum tax rate on ordinary income (35 percent in the United States for 2003). Taxable...

Back End and Deferred Loads

The first step is to calculate the beginning of period shares. As with the no load example, this is equal to the assumed investment of 1000 divided by the NAV at the end of the day the contribution is made. Any dividends received are assumed to be reinvested and reinvest shares are calculated and accumulated to the end of the period.

Unearthing Profit Opportunities

And so I bought Sears, Roebuck & Co., because its history shows that every three or four years a stock dividend is declared. This has been the practice of the company for many years. By this method Scars, Roebuck & Co. keep the cash in their business and use it for healthy and profitable expansion. The stockholder who owns a hundred shares is given twenty-five or thirty-three shares of new stock, which adds to his income without cutting down the working capital of his company. This twenty-five or thirty-three shares additional will, in ensuing years, probably yield another six or eleven shares and these, in turn, will eventually breed other little stock dividends, all of which, added to the original shares, should The purchase of a stock like Delaware, Lackawanna & Western Railroad is one which I made for an entirely different reason. Its dividend yield did not attract me, but having been over the property I realized what an enormous amount had been expended on improvements...

Suppose You Observe The Investment Performance Of 350

Consider a mutual fund with 200 million in assets at the start of the year and with 10 million shares outstanding. The fund invests in a portfolio of stocks that provides dividend income at the end of the year of 2 million. The stocks included in the fund's portfolio increase in price by 8 , but no securities are sold, and there are no capital gains distributions. The fund charges 12b-1 fees of 1 , which are deducted from portfolio assets at year-end. What is net asset value at the start and end of the year What is the rate of return for an investor in the fund

Adjustments for Non DividendPaying Companies

Dividends are the primary way companies repay their shareholders for providing investment capital, but not all companies pay dividends. The degree to which companies choose to return capital in the form of dividends has changed over the past 20 years. As Figure 6.1 shows, from 1960 through 1998 the dividend payout ratio for the S& P 500 Index the ratio of annual dividends paid as a percentage of the annual reported earnings averaged 50 percent (Bernstein, 2005b) and never fell below 39 percent. Half of Corporate America 's profits were paid to shareholders in the form of dividends. Figure 6.1 Dividend Payout Ratio for the S& P 500, I960 through 2006 Figure 6.1 Dividend Payout Ratio for the S& P 500, I960 through 2006 It is worth further exploring how share repurchases are becoming a more accepted way to compensate stockholders. Once considered a fraction of shareholder compensation, share repurchases have grown by leaps and bounds. Share repurchases increase the corporation's...

Valuation of Alternative Investments

Valuation of The owner of a preferred stock receives a promise to pay a stated dividend, usually each quarter, Preferred Stock for an infinite period. Preferred stock is a perpetuity because it has no maturity. As was true with a bond, stated payments are made on specified dates although the issuer of this stock does not have the same legal obligation to pay investors as do issuers of bonds. Payments are made only after the firm meets its bond interest payments. Because this reduced legal obligation increases the uncertainty of returns, investors should require a higher rate of return on a firm's preferred stock than on its bonds. Although this differential in required return should exist in theory, it generally does not exist in practice because of the tax treatment accorded dividends paid to corporations. As described in Chapter 3, 80 percent of intercompany preferred dividends are tax-exempt, making the effective tax rate on them about 6.8 percent, assuming a corporate tax rate of...

Taxes laws and reputation

In cases where it turns out that the suggested structure will be adverse to maximizing income from the investment for the investor, a restructuring of the fund is recommended. For example, some countries treat income derived from dividends or income derived from interest different in their laws pertaining to capital gains taxes. Income from dividends might be taxed higher than the comparable income from interest. In this case, if the sponsor had previously planned to structure the offshore fund as a dividend paying income note, he will be well advised to reconsider restructuring his vehicle as a bond paying interest.

Testing market efficiency

There are a number of different ways of testing for market efficiency, and the approach used will depend in great part on the investment scheme being tested. A scheme based upon trading on information events (stock splits, earnings announcements or acquisition announcements) is likely to be tested using an 'event study' where returns around the event are scrutinized for evidence of excess returns. A scheme based upon trading on a observable characteristic of a firm (price earnings ratios, price book value ratios or dividend yields) is likely to be tested using a 'portfolio' approach, where portfolios of stocks with these characteristics are created and tracked over time to see if, in fact, they make excess returns. The following pages summarize the key steps involved in each of these approaches, and some potential pitfalls to watch out for when conducting or using these tests. An event study is designed to examine market reactions to, and excess returns around specific information...

Stock Market Indexes Pricing and Risk

In this section we discuss how Dow Jones, Standard and Poor's, NASDAQ, and Value Line calculate their indexes. These indexes depend on stock price, number of shares issued, stock splits, and dividends. However, these are not independent. For example, if a 50 stock with 100 shares issued splits two-for-one, then after the split there are 200 shares, each worth 25. If a 50 stock pays 10 stock dividend (worth 5 a share), then after the dividend the stock is worth 50 1.1 45.45. where d is the new divisor. Solving for d gives d 3.5. This new divisor stays in effect until there is another stock split, a stock dividend of 10 or more by one of the companies, or a replacement of an existing company by a new company. Now, consider the effect of not adjusting for stock dividends of less than 10 . Suppose that the prices of our four stocks are 15, 10, 20, and 25, and that d 3.5 the share prices and divisor immediately following the stock split of company T. If company U issues a stock dividend of...

Reit Stocks Are For Trading

First, REIT stocks needn't be bought and sold frequently indeed, they are the ultimate buy and hold investment. Their total return performance, averaged over many years, has been outstanding, and certainly competitive with the broader equities markets. More than 50 percent of their returns to investors come from the dividend yields, so investors get paid to wait for the additional reward of stock

Macroeconomic Influences

In addition to structural inefficiencies that can be captured by investors, there are fundamental factors that dictate the strength or weakness of various currencies. Although currency is a transfer of wealth mechanism rather than an asset per se, the volatility in valuations among different currencies creates opportunities for trading profits. In this sense, currency volatility is a potential source of return. There is no implied rate of return for currency as there is in equities, which can be valued through the dividend discount model. Nevertheless, there are macroeconomic influences that cause currency exchange values to fluctuate. Macroeconomic factors that affect

Forward and Spot Inflation Expectations

The interpretation of o f is that it is the average compound rate of inflation per annum the market expects between the current time and time t. For example, if t is 1o, it is the compound average rate of inflation over the next ten years. This is probably the meaning people normally ascribe to the phrase inflation expectations over the next ten years''. This measure of inflation expectations has many applications. For example, it can be used in equity valuation models, which build up nominal dividend expectations from real dividend growth expectations and inflation expectations.

Will equity value be the same under firm and equity valuation

This firm valuation model, unlike the dividend discount model or the FCFE model, values the firm rather than equity. The value of equity, however, can be extracted from the value of the firm by subtracting out the market value of outstanding debt. Since this model can be viewed as an alternative way of valuing equity, two questions arise -Why value the firm rather than equity Will the values for equity obtained from the firm valuation approach be consistent with the values obtained from the equity valuation approaches described in the previous chapter

Calculation of Return to Stockholders

Return to stockholders includes any dividend payments plus the increase (or minus the decrease) in stock price that investors experience during an investment holding period. The market's focus is on yearly or annualized return to stockholders, as measured by percentage gains or losses, and usually uses the calendar year as the calculation period. Return to stockholders refers to an annual return, which is equal to the sum of the dividends paid plus the net change in a stock's price, divided by the beginning price of the stock.

But most newer ETFs are organized as openend funds

Having been allowed by the SEC to organize as open-end funds in 1996, most of the newer ETFs, such as the Barclays' iShares and State Street's streetTRACKS, are organized with an open-end mutual-fund structure. As such, they can be formed as different series of a single trust or even as a different class of shares of an existing fund, as the SEC allowed with the Vanguard VIPERs product. Also, open-end ETFs can reinvest cash dividends as often as on a daily basis, just like open-end mutual funds. In contrast, ETFs with a UIT structure must accrue cash dividends for the stocks in the trust and pay dividends only on a quarterly basis. This has created what is known in the industry as a cash drag on the performance of UIT-type ETFs

The Value with Retention and Sale

This strategy is consistent with the manner in which private equity is managed. The advantage of the retention strategy compared to a dividend is 47.86 for the example or an increase of .59 above the future value with the annual dividend. Most corporations have a mixed strategy of paying out a percentage of their earnings and retaining the remainder. Thus the actual difference in value for a typical dividend-paying corporation will not be as dramatic as for the example. But if we consider the change in value for the dividend component only, the example is accurate.

Share Prices and Dividends

We model separately the dividend yield on stocks, and the force of dividend inflation. The share dividend yield in year t,y(t) is generated using The force of dividend growth, 8d(t), is generated from the following relationship A dividend yield effect where a fall in the dividend yield is associated with a rise in the dividend index, and vice versa (i.e., dy < 0). A price index for shares, P(t), can be constructed from the dividend index and the dividend yield, P(t) D(t) y(t). The overall return on shares each year py(t) can be summarized in the gross rolled up yield,

Am Buying A Firm With An Expected Perpetual Cash Flow Of 1 000 But Am Unsure Of Its Risk. If I Think The Beta Of The

Based on current dividend yields and expected capital gains, the expected rates of return on portfolio A and B are 11 and 14 , respectively. The beta of A is 0.8 while that of B is 1.5. The T-bill rate is currently 6 , while the expected rate of return of the S& P 500 Index is 12 . The standard deviation of portfolio A is 10 annually, while that of B is 31 , and that of the index is 20 .

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