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

KEY POINTS

• Common stock is an equity security representing an ownership interest in a corporation. As an equity owner, common stockholders are entitled to the earnings of the corporation when those earnings are distributed in the form of dividends.

• The most commonly used measure of the performance of a corporation is its earnings. Earnings per share—the ratio of earnings available for common shareholders divided by the number of common shares out-standing—indicates each share’s portion of how much is earned by the company in a given accounting period. Because of potential dilution of earnings due to the presence of dilutive securities, earnings per share is reported in two ways in the financial statement: basic earnings per share and dilutive earnings per share.

• A dividend is the cash, stock, or any type of property a corporation distributes to its shareholders. The cash dividends that a corporation pays are described in terms of dividend per share or dividend payout ratio. The dividend payout ratio is the complement of the retention ratio. A corporation’s dividend policy is usually one of the following: (1) no dividends, (2) constant growth in dividends per share, (3) constant payout ratio, or (4) low regular dividends with periodic extra dividends.

• Because common stock never matures, today’s value is the present value of an infinite stream of cash flows. For the valuation of common stock, investors look at the current dividend and make assumptions about any future ...