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Wize University Introduction to Finance Textbook > Equity Valuation

Equity Basics

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Equity Basics

Stocks
  • Are ownership positions in a corporation
  • Payouts to common stock are dividends: o Cash or Stock Dividends
  • Unlike bonds, payouts are uncertain in both magnitude and timing
  • Like bonds, equity can be sold at any point in time.

Legal Structure

  • Residual claimant to corporate assets (paid after bondholders)
  • Limited liability: worst-case scenario is not that extreme
  • Voting rights on major corporate decisions

Dividends

  • Profits that the company does not reinvest and instead distributes to the shareholders.
  • The board of directors and management of the company determine how much they will pay to shareholders.
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Common Vs Preferred Equity


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The Dividend Discount Model (DDM)

In finance and investing, the dividend discount model is a method of valuing the price of a company's stock based on the fact that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.

How it Works

  • All future dividends are discounted back to the present time
  • The present value of future dividends is considered the fair value of the stock
  • Discounting is done using a required rate of return that is based on how risky the stock is.



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Required Rate of Return

  • The minimum return on investment investors expect to earn on a stock.
  • Is found by adding a risk premium to the risk-free rate
  • Risk-free rate is the return an investor can earn by investing in risk-free government investments.
  • Risk premium increases if a stock is more risky and decreases if a stock is less risky



Extra Practice
On January 1, 2023, you purchased 100 shares of WIZE Corporation. On February 4, 2023, the company declared a dividend of $3 per share for shareholders of record on March 21, 2023, payable on April 4, 2023. If you wished to receive the dividend, you cannot sell your shares before:
The value of common shares depends on
In the case of a liquidation of assets due to a bankruptcy, the correct order of priority is:
Which of the following is not a true statement?
Which of the following statements about equity securities is/are correct?
I. There is no fixed maturity date
II. They represent ownership in the corporation
Which of the following statements about equity securities is/are correct?
I. There is no fixed maturity date
II. They represent ownership in the corporation
Common shares include which of the following characteristics:
I. The right to vote for the board of directors
II. Right to receive income before any creditors
Which of the following statements is/are TRUE?
I. Preferred shares pay constant dividends and common shares dividends are determined each year by the board of directors.
II. Common shareholders have priority over preferred shareholders since they are the real owners of the business.