Common stock
It is a form of corporate equity ownership,
which is also a type of security. It offers an
opportunity for higher long-term returns
compared with bonds but comes with
greater risk. That is why common stock
valuation is an essential factor in
determining a stock's price.
Unlike with preferred stock dividends and
bonds, which are set by contract, and they
are valued in much the same way, common
stock dividends are not contractual, as they
depend on the firm’s earnings.
I. Control of the Firms
Common stockholders control the firm
through their right to elect the company's
board of directors, which appoints
management.
State and federal laws stipulate how
stockholder control is to be exercised.
II. Voting Rights
The common stockholders also have the
right to vote.
They can appear at annual meetings and
vote in person or it can also be through a
proxy.
Proxy
A proxy is a person who represents a
member in the shareholders' meeting of a
company, with a legal document that could
prove their authority, typically the power to
vote shares of common stock.
For a person to act as a proxy for an
individual, formal documentation may be
required that outlines the extent to which the
proxy can speak on the individual's behalf.
Usually, a management company always
solicits stockholders’ proxies and usually
receives them. However, if the performance
of that person is poor and stockholders are
dissatisfied, this is when an outside group
may solicit the proxies in an effort to
overthrow management and take control of
the business.
Proxy Fight
A proxy fight or or also known as a proxy
contest or a proxy battle, refers to a
situation in which a group of common
shareholders in a company join forces in an
attempt to oppose or vote out the current
management or board of directors.
Proxy fights are typically difficult to win to
companies who have various governance
tactics in place and also include restrictive
requirements in its bylaws. Therefore, most
proxy fights by shareholders are
unsuccessful.
Takeover
Takeover is an action whereby a person or
group succeeds in ousting a firm’s
management and taking control of the
company. Some managers’ in a company
who move to make takeovers more difficult
have been countered by stockholders,
especially large institutional stockholders,
who do not like barriers erected to protect
incompetent managers.
III. PREEMPTIVE RIGHT
A preemptive right is a provision in the
corporate charter or bylaws that gives
common stockholders the right to purchase
on a pro rata basis new issues of common
stock or convertible securities.
The common stockholders often have the
right, that is called the preemptive right to
purchase on a pro rata basis any additional
shares sold by the firm.
Purpose of Preemptive Right
● To prevent the management of a
corporation from issuing a large
number of additional shares and
purchases those shares itself.
● To protect stockholders from a
dilution of value.
IV. Dividends right

Dividends are a form of income that
shareholders of corporations receive for
each share of stock that they hold.
Dividends are important in a company
because it can be an indicator of financial
liability.
The common stockholder may also be
entitled to receive dividends, which are
payments made by the corporation to its
shareholders out of the profits.
The Board of directors determines the
amount and frequency of the dividends, and
common stockholders are typically entitled
to receive dividends on a pro rata basis.
V. Inspection Rights
The inspection rights or the opportunity to
inspect corporate books and records.
Common stockholders have the right to
inspect the corporation’s books and records
to ensure that the corporation is being
managed properly. They have the right to
know not only the financial condition of the
corporation but also how the corporate
affairs are being managed, so that if they
find the condition unsatisfactory, they may
be able to take the necessary measures to
protect their investments.
TYPES OF COMMON STOCK
Classified Stock
Common stock that is given a special
designation such as Class A or Class B to
meet special needs of the company
Founders’ Shares
Stock owned by the firm’s founders that
enables them to maintain control over the
company without having to own a majority
of stock.
Golden Shares
Golden shares provide special power in the
form of veto power to the holder of the
shares.
Stock Price
Stock price is simply the current market
price, and it is easily observed for publicly
traded companies.
Intrinsic value
Intrinsic value, which represents the “true”
value of the company’s stock, cannot be
directly observed and must instead be
estimated.
Intrinsic Value Formula
● Intrinsic Value = (Stock Price -
Option Strike Price) x (Number of
Options)
Two basic models are used to estimate
intrinsic values
● Discounted dividend model
● Corporate valuation model
DISCOUNTED DIVIDEND MODEL
The analysis as performed by the marginal
investor, whose actions actually determine
the equilibrium stock price, is critical, but
every investor, marginal or not, implicitly
goes through the same type of analysis.
Formula for Discounted Dividend Model
Stock Value = D1
r-g
D1 = expected dividend of the period
r = Rate of return of dividends
g = Growth rate of dividends

REQUIRED INPUTS:
A. REQUIRED RATE OF RETURN
Required Rate of Return, rs
- The minimum rate of
return on a common
stock that a value of the stock. The formula for
stockholder considers
acceptable or
worthwhile to own a
stock.
- also referred to as the
“cost of equity”
Determining Required Rate
of Return
(Dividend Payment / Stock
Price) + Dividend Growth
Rate
Practice Problem:
In July 2018, Coke was trading at nearly
$45 per share. Its annual dividend per share
was projected to be $1.56. Coke has
increased its dividends by roughly 5% per
year, on average.The rate of return for Coke
is:
Rate of return= (Dividend Payment / Stock
Price) + Dividend Growth Rate
Rate of Return= ($1.56/45) + .05 = .0846, or
8.46%
In other words, an investor can expect an
8.46% annual return based on its current
share price.
B. GROWTH RATE
Growth Rate, g
The expected rate of
growth in dividends per
share.
TYPES OF DIVIDEND DISCOUNT MODEL
● The Gordon Growth Model
The most common DDM is the
Gordon growth model, which uses
the dividend for the next year (D1),
the required return (r), and the
estimated future dividend growth
rate (g) to arrive at a final price or
the Gordon growth model is as
follows:
● Stock Value= D1 / r-g
● Zero Growth Dividend Discount
Model
The zero growth DDM assumes that
all future dividends of a stock will be
fixed at essentially the same dollar
value forever, or at least for as long
as an individual investor holds the
shares of stock. In such a case, the
stock’s intrinsic value is determined
by dividing the annual dividend
amount by the required rate of
return:
Formula: Stock Value= Annual Dividends/
Required Rate of Return
Example:
What is the intrinsic value of a stock that
pays $2.00 in dividends every year if the
required rate of return on similar
investments in the market is 6%?
Solution:
We can apply the zero growth DDM formula
to get
Stock Value= $2.00/0.6 =$33.33
While this model is relatively easy to
understand and to calculate, it has one
significant flaw: it is highly unlikely that a
firm’s stock would pay the exact same dollar
amount in dividends forever, or even for an
extended period of time. As companies
change and grow, dividend policies will
change, and it naturally follows that the
payout of dividends will also change.

● Constant Growth Dividend

Discount Model

As indicated by its name, the

constant growth DDM assumes that
a stock’s dividend payments will
grow at a fixed annual percentage
that will remain the same throughout
the period of time they are held by
an investor. While the constant
growth DDM may be more realistic
than the zero growth DDM in
allowing for dividend growth, it
assumes that dividends grow by the
same specific percentage each year.

The constant growth DDM formula is:

Stock Value= D0 (1 + g) / r − g

Practice Problem for DDM: Using Gordon

Growth Model

Using the same problem, In July 2018,

Coke was trading at nearly $45 per share.
Its annual dividend per share was projected
to be $1.56. Coke has increased its
dividends by roughly 5% per year, on
average.

Let’s say you want to see a 10% return.

What would the appropriate stock value be
based on the current dividend per share and
growth rate and return?

Stock value = Dividend per share /

(Required Rate of Return – Dividend
Growth Rate)

Stock value = $1.56 / (0.10 – 0.05) = $31.20