What exactly is a stock???

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Hello,
I’ve been reading this forum with interest now and I keep reading the word, “stock”. I was actually born and raised on a farm and I didn’t think they had much “livestock” runnin round Wallstreet.

See now this is getting to be a good discussion…

Which of the following is a definition of a stock:
a) Rock spelled with a “st”
b) A call option on the assets of the company
c) A claim on a fixed percentage of future dividends
d) A right to vote on corporate governance matters

I’d say c) hence the reason some analyst spend so much time perfecting their DCF models! Sure the word “fixed” appears suspicious, but a stock’s value at any time assumes a fixed percent when considering the preferred shares that are in line ahead of a common share holder. This is why a stock’s market price is quickly impacted on news regarding preferred stock etc.
A stocks price should theoretically be the PV of all future dividend payments. Sounds easy right? Well good luck estimating inflation, reinvestments rates, and growth rates into perpetuity.

“A stocks price should theoretically be the PV of all future dividend payments. Sounds easy right? Well good luck estimating inflation, reinvestments rates, and growth rates into perpetuity.”
So then a stock that doesn’t pay dividends is worth nothing?

Yeah that didn’t make sense to me either.

> So then a stock that doesn’t pay dividends is worth nothing?
dont you know??? that is how buffett became so rich. he keeps all his $$ instead of giving it back to the investors via dividends. smart man.

Theoretically if a stock will “never” pay dividend then yes it should be worth nothing, but I’m unaware of a company that never intends to distribute profits to its equity holders (at some point in time). Even if a dividend is not paid and a company goes private or is bought out the shareholder will capture the future expected free cash flows in exchange for their share of the company (i.e. future dividends).
Granted non-dividend paying companies, i.e. a growth companies are unlikely to pay a dividend when it is in a growth phase but if the company exists long enough it eventually will and that is what the stock price is trying to capture. Hell Microsoft had to eventually cave and distribute some of the cash it was sitting on.

“Theoretically if a stock will “never” pay dividend then yes it should be worth nothing”
That’s just wrong, and illustrates why the DDM is for academia, not for the markets.

skillionaire, please explain how that is wrong.
If a company said hey buy shares in our firm, in exchange you have the right to vote proxies and be invited to our conference calls, otherwise you’re never going to get a return on your investment unless we liquidate. I don’t believe anyone in their right mind would pay any multiple of the net assets value.
I’m not big on the academia blinders vs reality either, but for the sake of answering Joey’s multiple choice question, I believe it’s the most reasonable choice (c)

“I don’t believe anyone in their right mind would pay any multiple of the net assets value.”
So the people who bought Microsoft in the 20 years before they declared dividends were out of their mind? No offense, and I apologize in advance if this comes off a little harsh, but did you think about that before you typed it?

that was a mess… lemme try again

is a company that never pays a dividend, but repurchases its own shares worth $0?
Also, take a look at Berkshire’s dividends and then let me know what you think the stock is worth.

“So the people who bought Microsoft in the 20 years before they declared dividends were out of their mind? ”
Skillionaire, you have yet to provide any substantive explanation of your opinion aside from some ad hominem responses. If you read my prior posts carefully you’ll see that is not what I’m saying. My point is the investor captures the “dividend” as either a current dividend payment or a buyout of the company share(s) which itself is priced considering the future cash flows (i.e. future dividends). I think you’re still sticking with your prior choice (a),but I disagree with that answer (although in the end it may end up being right) but why would someone pay a multiple of a company’s net assets? It would be better if (a) said a claim on the company’s FUTURE net assets. Choice (a) sounds more like a claim (albeit last in line) on current company assets and does not consider the future value of the firm.
Joey, you started this mess.

nolabird032 Wrote:
——————————————————-
> is a company that never pays a dividend, but
> repurchases its own shares worth $0?
>
> Also, take a look at Berkshire’s dividends and
> then let me know what you think the stock is
> worth.
no, but if continued into perpetuity it is slowly becoming a private company, the remaining shareholders have to adjust future expectations of dividends and cash flows. For some reason the concept (yes it’s an academic concept) is rubbing people the wrong way. Perhaps it’s the idea of a dividend as a steady payment, when it should be looked at more as a distribution of the earning capacity of the company; either captured as a current $ payment or estimated as a future value.

“buyout of the company share(s) which itself is priced considering the future cash flows (i.e. future dividends).”
Char-Lee, I don’t mean to nit-pick, but you may need to further qualify this statement. When valuing a company for buyout/acquisition purposes, the proper valuation metric would be the FCFF rather than the dividend. This is primarily because it is assumed that the acquirer will have a controlling interest in the firm and thus can control the dividend policy.
Or maybe I misunderstood…

Also, what if a company decides to retain a larger and larger percentage of it’s CFs (i.e. less dividends) does this mean that the value of the company should decrease….not necessarily. Less dividends can mean more growth (ROE x retention rate = g) which can lead to a higher security value (V = [FCFE(1+g)]/[Re - g]).

my point is that it doesnt matter how or when the earnings are distributed (steady or periodically) or even what you want to name the payment (dividend, share repurchase, coupons). What differentiates debt from equity is the underlying concept of ownership.

“skillionaire, please explain how that is wrong.”
*banging head on wall*
Char-Lee, it’s wrong because it’s assuming that the DDM is anything more than a formula to remember for CFA Level I. Re-read your Level I text for the shortcomings of the formula, and then if you have questions we can debate all that you like.

skillionaire Wrote:
——————————————————-
>
> *banging head on wall*
>
hoping one of those blows will render skillionaire unconscious.

bryant Wrote:
——————————————————-
> “buyout of the company share(s) which itself is
> priced considering the future cash flows (i.e.
> future dividends).”
>
> Char-Lee, I don’t mean to nit-pick, but you may
> need to further qualify this statement. When
> valuing a company for buyout/acquisition purposes,
> the proper valuation metric would be the FCFF
> rather than the dividend. This is primarily
> because it is assumed that the acquirer will have
> a controlling interest in the firm and thus can
> control the dividend policy.
>
> Or maybe I misunderstood…
no, you’re right and it is something I’ve tried to capture in my seemingly convoluted prior posts. I’m making a stretch here by calling FCFF a dividend suggesting that eventually those cash flows will reach the shareholders one way or another…
I didn’t particularly like any of the four choices in Joey’s question, and thought that I could bend (c) to be the best answer. nola is right about ownership, but to me the way answer (a) was phrased seemed be distinguishing between assets in place and ignoring the company as a going concern. A “stock” is nothing more then the last hand in line for claims to the firm, and I believed the spirit of the question was getting at what constitutes the value of a stock.
I’m leaving at that and going to open a nice cold beer.

Wow - good discussion. I especially liked the part where Char-Lee wished that skillionaire would knock himself unconscious. I would like to add that I would like the video of such a head-banging on YouTube.

very funny.

Frsutatation Take a break from your studies

ymc, I saw that thread. The material difference is that while the other person might be genuinely interested in how to finance a car loan, this thread is just bryant asking a tongue-in-cheek question.

lola,
you know my soul…you sitting for level I this Dec?

I thought that at one point there was livestock on wall street. so i googled and…
History of Wall Street -
On Manhattan Island, a wall was built between the Dutch commune and their outlying farms to protect against wild animals and Indians. This is the wall for which today’s Wall Street is named.

nolabird032 Wrote:
——————————————————-
> I thought that at one point there was livestock on
> wall street. so i googled and…
>
> History of Wall Street -
>
> On Manhattan Island, a wall was built between the
> Dutch commune and their outlying farms to protect
> against wild animals and Indians. This is the wall
> for which today’s Wall Street is named.
You are definitely an analyst by nature.

bryant Wrote:
——————————————————-
> lola,
> you know my soul…you sitting for level I this
> Dec?
*puts away crystal ball*
yes, I am. It’s my first attempt and I’m getting in panic mode already :)

Which of the following is a definition of a stock:
a) An ownership interest in the assets of a company
b) A call option on the assets of the company
c) A claim on a fixed percentage of future dividends
d) A right to vote on corporate governance matters

or i read The Great Game a couple years ago. actually i like your answer better. lets go with that.

I think b) can’t be correct in all cases because you don’t get dividend by owning call options.

a) would be my best guess

What is the biggest city in the world?
Dublin, because it keeps on doublin and doublin…

I think the joke is what’s the richest country in the world? Ireland becauise its capital is always Dublin.

lola Wrote:
——————————————————-
> bryant Wrote:
> ————————————————–
> —–
> > lola,
> > you know my soul…you sitting for level I this
> > Dec?
>
>
> *puts away crystal ball*
>
> yes, I am. It’s my first attempt and I’m getting
> in panic mode already :)
Assuming you put forth an effort, you should do just fine. Review the practice problems, memorize your formulas, go into the exam well prepared, then pass the test. Nothing to it!

Joey, it’s a) by process of elimination, although with a far-fetched but not unrealistic scenario I could eliminate that option as well.

But we want a discussion about the choices because that’s fun and educational. Like why did you eliminate the other choices?

Don’t take the bait skillionaire, he’s walking you into his web.

I’ll bite. (I mean, if you’re going to get b!tch-slapped by someone, you could do worse than Joey.)
You could perhaps eliminate all choices:
a) stockholders don’t have ‘ownership’ in the legal sense – they can’t sue for title
b) ditto – stock might be likened to a call on the value of the company
c) new higher-priority stock (e.g. preferreds) can interrupt dividend priority
d) lots of nonvoting stock out there

That’s all right, I’ll be Joey’s whipping boy.
a) most reasonable, although if the company has negative equity you’re fugged (also standing in line behind senior and mezz debt holders, so by definition that sucks)
b) no call option; you have zero say in the matter of liquidation, and there’s a fairly likely chance you’re left holding nothing but your twig and pebbles
c) assumes that there will be explicit dividends (wording was designed to give myself some fudge room in case you try to come back that any capital gains on the stock are really implicit dividends)
d) assumes that whatever class of stock you buy will have voting rights
Given that none of these answers are right 100% of the time, if forced to pick, I’d still have to go with “a”.

I should note I just got b!tch-slapped by investopedia:
Stock: A type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings.

Yeah, “a” is certainly the best answer out of the choices, but even that sucks as well. What “claim” do you have if the company has negative equity? Then the company has a “claim” on you, not the other way around…….

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