Stock Fundamentals: Equity, Valuation, and Shareholder Powers

Understanding Common and Preferred Stock

Par Value Explained

Par Value: The stated value on a stock certificate.

• An accounting value, not market value.
• Represents the dedicated capital of a corporation, calculated as the total par value (number of shares * par value of each share).

Authorized vs. Issued Common Stock

• The articles of incorporation must state the number of shares of common stock the corporation is authorized to issue.
• The board of directors, after a vote of the shareholders, may amend the articles of incorporation to increase the number of shares.
• Authorizing a large number of shares may concern investors about dilution because authorized shares can be issued later with the approval of the board of directors but without a vote of the shareholders.

Capital Surplus Defined

Capital Surplus: Refers to amounts of directly contributed equity capital in excess of the par value.

Retained Earnings Explained

Retained Earnings: The earnings that are not paid out as dividends. Not many firms pay out 100 percent of their earnings as dividends.

Key Stock Valuation Concepts

Market Value (Market Capitalization)

Market Value (Market Capitalization): Price of the stock * number of shares outstanding.

Book Value

Book Value: The sum of par value, capital surplus, and accumulated retained earnings is the common equity of the firm.

Replacement Value

Replacement Value: The current cost of replacing the assets of the firm.

(Note: At the time a firm purchases an asset, market value, book value, and replacement value are typically equal.)

Shareholder Rights and Voting

• The right to elect the directors of the corporation by vote constitutes the most important control device of shareholders.
• Directors are elected each year at an annual meeting by a vote of the holders of a majority of shares who are present and entitled to vote. The exact mechanism varies across companies.
• An important difference is whether shares are to be voted cumulatively or straight.

Cumulative Voting

Cumulative Voting: The total number of votes that each shareholder may cast is determined first. Usually, the number of shares owned or controlled by a shareholder is multiplied by the number of directors to be elected. Each shareholder can distribute these votes over one or more candidates. This permits minority participation.

Straight Voting

Straight Voting: Shareholders have as many votes as shares, and each position on the board has its own election. There is a tendency to freeze out minority shareholders.

Proxy Voting

Proxy Voting: A proxy is the legal grant of authority by a shareholder to someone else to vote his or her shares. For convenience, the actual voting in large public corporations is usually done by proxy.