1.2 Equity Income, Tax & Analysis
This chapter follows what a stockholder actually receives and how to judge a stock. It covers dividends and how they are valued, splits, the tax on dividends and gains, fundamental and technical analysis, and the suitability of common and preferred stock. For exam purposes it combines calculations you must be able to do with the risk and investor-profile questions that make up much of the suitability section. For a client, it explains what a stock pays, what it costs in tax, and who it fits.
What each topic covers
Dividend Discount & Growth Models explains that the board decides on dividends and that smaller growth companies usually pay none. It then gives two valuation formulas. The dividend discount model is annual dividend divided by the discount rate and is used for preferred stock. The Gordon growth model divides by the discount rate minus the dividend growth rate and is used for common stock.
Splits, Stock Dividends & Ex-Dates works through the split and stock dividend formulas. A 4:1 forward split turns 100 shares at $500 into 400 shares at $125, and a 1:5 reverse split raises the price. Splits need stockholder approval and stock dividends do not. Buyers who purchase before the ex-dividend date receive the dividend, and buy limit and sell stop orders are reduced by the dividend on that date.
Qualified Dividends & Capital Gains sets qualified dividends at 15% or 20% against up to 37% for non-qualified dividends. Corporations exclude 50% of dividends, or 65% when they own 20% or more of the issuer. It defines cost basis and sales proceeds, the one year and one day rule for long-term gains, 1099-DIV and 1099-B reporting, and FIFO, LIFO and specific share identification.
PE Ratio & Equity Valuation separates fundamental from technical analysis and distinguishes the audited 10-K from the unaudited 10-Q. The PE ratio is market price divided by earnings per share. A high PE is typical of growth companies, a low PE of value companies, and PE ratios often fall in the 15 to 25 range.
Trends, Breadth & Market Theories covers trend lines, moving averages and the advance/decline line. An overbought market is still rising but is a bearish signal, and an oversold market is still falling but is a bullish signal. It also covers consolidation, support and resistance, breakouts, the odd lot theory, and the short interest theory, under which high short interest is bullish.
Chart Formations & Reversals describes the four reversal patterns chartists use. Saucer bottoms and head and shoulders bottoms are bullish and suggest going long. Saucer tops and head and shoulders tops are bearish and suggest selling short. The lesson also contrasts fundamental analysis, which asks what to buy, with technical analysis, which asks when.
Common Stock Risk & Investor Profile applies the BRTI framework of benefits, risks and typical investor. The benefits are capital appreciation, dividends and an inflation hedge. Market risk and inflation risk are systematic and cannot be diversified away, while financial, business, regulatory, liquidity and concentration risk are non-systematic. It adds the dividend payout ratio, market cap categories, penny stocks and the rule of 100.
Preferred Stock Risk & Investor Profile treats the fixed dividend as the main benefit: 10,000 shares of 5%, $100 par preferred pay $50,000 a year if the board approves. Risks include skipped dividends, bankruptcy, interest rate risk, inflation risk and call risk. Preferred stock suits income-seeking, moderate-risk investors with long time horizons, and corporations that benefit from the dividend exclusion.