The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

CHAPTER 8

Fundamentals of Common Stock

Frank J. Fabozzi, Ph.D., CFA, CPA Professor in the Practice of Finance Yale School of Management

 

Frank J. Jones, Ph.D. Professor, Accounting and Finance Department San Jose State University

 

Robert R. Johnson, Ph.D., CFA Senior Managing Director CFA Institute

 

Pamela P. Drake, Ph.D., CFA J. Gray Ferguson Professor Finance College of Business James Madison University

 

 

 

 

 

Common stocks are also called equity securities. Equity securities represent an ownership interest in a corporation. Holders of equity securities are entitled to the earnings of the corporation when those earnings are distributed in the form of dividends; they are also entitled to a pro rata share of the remaining equity in case of liquidation.

Common stock is only one type of equity security. Another type is preferred stock. The key distinction between the two forms of equity securities is the degree to which their holders may participate in any distribution of earnings and capital and the priority given to each class in the distribution of earnings. Typically, preferred stockholders are entitled to a fixed dividend, which they receive before common stockholders may receive any dividends. Therefore, we refer to preferred stock as a senior corporate security, in the sense that preferred stock interests are senior to the interests of common stockholders.

In this chapter, we explain the fundamental factors of earnings and dividends and we look at common stock ...