7- 2
                   Common Stock
     Background
       Stockholders own the corporation, but in 
         many instances the corporation is 
         widely held
          • Stock ownership is spread among a 
           large number of people
       Because of this, most stockholders are 
         only interested in how much money 
         they will receive as a stockholder
          • Most equity investors aren’t 
           interested in a role as owners
                                                                                                                  7- 3
                          The Return on an Investment in 
                                                 Common Stock
             The future cash flows associated with stock ownership consists 
                 of 
                  – Dividends and
                  – The eventual selling price of the shares
             If you buy a share of stock for price P , hold it for one year during 
                                                                            0
                 which time you receive a dividend of D , then sell it for a price P , 
                                                                              1                                       1
                 your return, k, would be:
                                   D+P-P 
                           k =       1       1    0
                                          P                         A capital gain (loss) occurs 
                                            0
                                      or                               if you sell the stock for a 
                               D                P -P                price greater (lower) than 
                   k =            1      +        1    0                         you paid for it.
                               P                   P
                                0                   0
                                                 
                          dividend yield   capital gains yield
                                              7- 4
        The Intrinsic (Calculated) Value and 
                    Market Price
     A stock’s intrinsic value is based on 
       assumptions made by a potential investor
        Must estimate future expected cash flows
          • Need to perform a fundamental 
            analysis of the firm and the industry
     Different investors with different cash flow 
       estimates will have different intrinsic 
       values
                                             7- 5
                  Price versus Earnings
                                              7- 6
         Developing Growth-Based Models
      Realistically most people tend to forecast growth rates rather 
       than cash flows
      A stock’s value today is the sum of the present values of the 
       dividends received while the investor holds it and the price for 
       which it is eventually sold
      An Infinite Stream of Dividends
        Many investors buy a stock, hold for awhile, then sell, as 
          represented in the above equation
           • However, this is not convenient for valuation purposes
            D       D           D       P
      P  =   1      2        n       n
       0  1k   1k2      1kn  1kn