The answer depends upon whom we mean by “investors”? Is investor the one who is already holding a share, that is, an existing shareholder, or one who is going to become a shareholder? Unfortunately there has been some confusion in this regard. To any reasonable person, it should be clear that is the existing shareholder who is the true investor since he has already invested. Whenever a company makes a public issue of shares at a price, which is lower than the market value of the share, some part of the wealth gets transferred from the existing shareholder to the new shareholder. It happens like this. Consider a company with 1lakh shares outstanding, quoted in the market at Rs.50 each. The total wealth of the existing shareholders can be said to be Rs.50 lakh. If this company raises another Rs.10 lakh by issuing Continue reading
Stock Investments
Gordon Growth Model or Constant Growth Model of Common Stock Valuation
Common stock represents ownership of the corporation. So the common stockholders are the owners of the firm. They elect the firm’s board of directors, who in turn appoint the firm’s top management team. The firm’s management team then carries out the day-to-day management of the firm. A share of common stock is more difficult to value in practice than a bond, for at least three reasons. First, with common stock, not even the promised cash flows are known in a advance. Second, the life of the investment is essentially forever, since common stock has no maturity. Third, there is no way to easily observe the rate of return that the market requires. Nonetheless, as we will see, there are cases in which we can come up with the present value of the future cash flows for a share of stock and thus determine its value. Stock valuation is the process Continue reading