Alan Kring Productions in association with the Emergent Light Studio presents the Illinois
State Collegiate Compendium, Academic Lecture in Business and Economics.
This is Business Finance, FIL 240 for autumn semester 2023.
Today stock valuation alternatives.
I will talk until about 420 and then we'll have the quiz five.
So everyone get ready for a fun time coming up.
Let me show you a couple of things here.
We'll get to the numbers in just a minute.
First things first, you got an announcement last night that there's now another place
where you can get the podcast lectures.
Now this one is special because this also gives you the transcripts of the lectures
as well.
And I've had this for a long, long time, but in order to put transcripts on it, I had to
up the game and get the highest level service.
But here's what you get when you go to rss.com slash podcasts slash Illinois dash state dot
collegiate dash, I'm sorry, compendium.
You will see that the podcasts are there.
Now I'm going to be back filling from the start of the semester over the weekend so
that everything up to this point will be there.
And once you get into the RSS feed, you just choose your lecture and you'll click here.
Now you'll see here transcript.
You're going to get a transcript and the audio of the lecture all together.
And it's actually very well done.
The only thing that irritates me is they spell my name wrong every time.
But there you go.
There it is.
Look, see they spell my name wrong.
God, that irritates me.
Anyway, enough of that.
But yeah, then you can go to the transcript and when you play it, you'll see that it's
actually running line by line what I'm saying.
Huh, do I have sound?
I don't have sound.
Huh, what do you know?
I don't have any sound here on the board.
What am I doing here wrong?
Huh, I wonder why it's not playing the sound.
Maybe the sound is off on this.
I don't know.
One way or the other, it will be there though and you'll hear sound.
And you'll have the transcript of the lecture.
And like I said, I'll be back filling.
This is the entire lecture in transcripted form.
It's partly as an accommodation, which I've been meaning to do for a long time.
And also, if you want to go back and do a search for a word, well where did he say capital?
Control F, capital, and it'll find it in the lecture by the virtue of just how websites
work.
You can do word searches.
I wish I knew why it was not playing the sound on this.
Huh, I don't know.
But anyway, one way or the other, this is just another place where you can get the podcasts
of the lectures here.
And I'm doing this all for you because I love you so much or something like that.
But yeah, this is a high end site.
It's a rather steep annual fee.
But I mean, you can't beat the transcription.
I tried transcription on YouTube and it is awful.
And this is top of the line.
Of course, that's RSS for you.
But anyway, there you go.
And you might want to bookmark this link.
This is very nice.
The site, they let me lay it out really, really nice.
So there you go.
Anyway, enough of that.
Let's have a look at the numbers.
As grim as these numbers are, they are bloody.
Now here's a little bit of interesting part here is the Dow was down only a third of a
percent.
But then you get to the Standard Port 500 and it was down 1 and 1 half percent almost.
That is quite a larger drop.
And then you get to the NASDAQ and that thing was just taken to the toilet for a beating.
Two and a half, almost two and a half percent down.
The real question is why is it losing its steam?
The economy is decent.
The Fed isn't going to jack up interest rates anytime soon.
But boy, was it a nasty day on the street.
Having a look over here, let's look at the SP500 volume for the day.
The volume was actually still well below the 52 week average.
It was 2.6 billion against the average over the last year, daily average of 3.7 billion.
But it was higher than it has been.
So it was an active day down.
Now notice something interesting.
You see these volume bars here?
Let me get this bigger.
See if I can make it a little bigger.
See those volume bars?
Notice that there was a high bar right there.
That was the first drop.
The bears coming in.
And then it just kind of blipped and farted around.
But look there at the end.
Right toward the end of the trading day, there was a lot of activity coming in.
What does that mean?
I'm not sure, but it didn't look like bear activity.
It was a lot of trading back and forth.
See if that had been a lot of sell orders, that would have been showing a drop in the
price.
But it wasn't a bear, a bull run, because there would have been a rise in the price.
So the volume was sort of balanced between bears and bulls because it just didn't do
much even though there was this steep volume.
It started out, see that drop?
It started out like that, but by the time of this major thing right here, it had already
stabilized.
I'm hard to tell what that means.
But anyway, now let me back down here.
Get back down to 100%.
Okay now, let's go back here and have a look at the rest.
Not surprisingly, well, not surprisingly, crude oil is staying nicely within that trading
band I had told you it would probably stay in there.
There it is, bouncing between 82 and 88.
It's right in the middle right now at about 85 and a quarter.
So we don't have anything to worry about as far as gas prices go.
They're not going to go down, certainly, but they aren't going to go be jumping up.
Now here's a little bit of a concern.
Look at gold.
It is trying to find that resistance at $2,000 an ounce.
That would indicate that the fear mongers and the apocalypse freaks are getting a little
bit more wind in their sails trying to get it, push it past, buying gold to push it past
$2,000 an ounce.
But they haven't gotten there yet.
Now interestingly, the Euro and the British pound and the Japanese yen all depreciated
against the dollar, which would indicate that the dollar is stronger than those currencies.
And it got stronger in the investors' judgments over the day.
So even though the market's down, it seems like the international currency markets are
still in favor of the dollar over the Euro, the pound, and the yen.
Ten-year bonds.
The price, or rather the yield was going way up, but that would mean that the price was
going down.
So there was a sell-off in the bonds.
Now if there's a sell-off in the bonds, that should have shown up in buying of equities,
but it did not.
It was just selling the bonds and putting the money into money market accounts, pulling
the money off the field.
Not pulling the money from one team and giving it to the other team.
It was pulling the money off the field.
So there was money getting out of equities, and there was money getting out of the good
alternative, which is bonds.
So what does that tend to mean?
It means that the investors are really wary.
They're thinking, let's put our money on the sidelines until we see what's about what's
going to happen.
So there you go, that's that part.
Now over on the other side of the Pacific, last night the Nikkei was bullish, but then
it lost its...the bears came in at the end.
They didn't drive it way down, but that strong sediment at the beginning kind of flattened
out and then the bears took over a little bit.
Finished up about two-thirds of a percent.
Now the London was choppy, just bouncing up and down.
More uncertainty.
Finished up, but there was a bear pull there at the end.
But it was certainly...we don't see a global version of what happened in our markets today.
On the bright side, if you look at these, the bear action happened at the beginning,
and then it ended just after lunchtime.
See how it flattened out?
No more selling.
And see how it flattened out?
Right there, it dropped off in the late morning, and then it stabilized and the same thing
happened with the NASDAQ.
So the sell-off didn't continue to the very end and the bell stopped everything.
The sell-off stopped in the very early afternoon.
What does that mean?
Well, it tells us that at least we know that whatever was bothering the equity investors
didn't last for very long.
Just curious, what about bonds?
Oh, that sell-off in the bonds, the yield just kept going up and up, which means that
the prices were going down and down.
So there was a sell-off in the bonds continued all through the day to the very end.
Okay, enough of that.
Let me show you something real quick.
And I've talked about this before.
There's a mistaken idea that you make money in a bull market, you lose money in a bear
market.
That's certainly not true.
All you have to do is know how to make money when stocks are going down.
Now, there is one way called short selling, and I'll teach you how to do that.
It has the disadvantage that you have to have a margin account.
You have to have money with the brokerage house in an account with them before they'll
let you do short selling.
There's another way that you can profit in a bear market.
All you do is buy ETFs that are bearish, that are contrarian.
Let me show you a couple real quick here.
SQQQ, let's try that again.
SQQQ.
Now it's called ultra short.
That short means bear.
Look at that.
The thing was up 7.3%.
That's bear activity.
You're making money in a bear market.
Notice how it's barely up in the aftermarket, so the bear activity is over.
But notice the beta.
Negative 3.42.
Negative beta.
It goes against the world portfolio.
It's going against it.
That's a bear.
In other words, it's bearish.
And that is hellaciously bearish.
That is a multiple of bearish.
As a matter of fact, the ultra gives you an indication that they're leveraging bear action
to get a magnification effect.
And so if it's a bear market, SQQ is really going to benefit from it.
As you see happen, bear market, SQQ up a staggering 7.3%.
Here's another one.
NPXU.
That's a bear market.
See short, bear.
That's on the standard port is 500.
It was up today, 4.22%.
Well everyone loses when it's a bear market.
No you don't.
Not if you play these.
But of course you're looking at it.
There you go.
Beta is negative 2.92.
There's the thing again.
It's negative.
It's contrary.
It operates against the world portfolio.
Oh is that the only two?
Oh no there are tons of them.
UDOW.
UDOW is a short on the Dow 30.
It probably won't be much.
Yeah.
It just kind of peas itself around.
See really, that's not really a short.
That's actually positive.
So that's why that one went down.
Let me try another one.
SPX, no I did SPXU.
What's another one?
Come on.
No.
Those are, well let me show you this one.
S Dow.
That's the one I was looking for.
S Dow.
Short.
So it was up.
S Dow.
In other words, it's contrarian.
Beta is negative 2.60.
So this is how you can do well in a bear market.
If you find these short securities and you just buy into them.
Look at this.
For only $27.39, you could take a position, a bear position.
Let me look at this last one.
Not UDOW, the other one.
SPXU.
$12.85 can buy you a share, a bear share.
Hey, that's cool.
A bear share.
Yeah.
So it doesn't take a lot of money to take a position.
And it doesn't take a lot of money to take a bear position.
So if the market's going to hell, if you think that's what's going to happen, well, you don't
just sit down and hide.
You just go to the bear side.
So you might be saying, well, wait a minute there, Professor.
Didn't you just say a lot of money is getting on the sidelines?
Yeah.
We see a lot of big money investors just taking their money off the playing field and getting
it into cash.
Why would they be doing that?
Because they don't know which way it's going to go.
They haven't decided bear or bull.
So if once they decide, they'll start taking positions on the bull side or on the bear
side.
But right now, they're not doing that so much.
It's just these investors who play in these bull and bear shorts that go for the bear
stuff today.
Boy, it was quite a day.
I want to go back there.
SQQ.
Yeah.
Boy, was that a good day.
But notice that the aftermarket is not doing that giant jump.
So in other words, it's like I said before, it looks like the bear, that bear activities
had already finished off by the end of trading.
See how it leveled out there?
So there was no more bear.
The bears had had theirs early and then everyone was just kind of sitting there looking stupid,
waiting for the next thing to happen.
So there you go.
What does that mean for tomorrow?
Well, it's kind of hard to say because there's always news going on overnight.
But as of right now, that bear throw up vomit that happened earlier has passed for now.
Anyway, that is the fun that I want to have with you on markets.
Now this is sort of a tie up of what I've said in other lectures, at least the first
part of it.
And then just a couple of formulas to finish off this subject.
And essentially I'm talking about stocks here.
Stock.
Otherwise known by the fancy term equity.
So remember, if you are trying to be impressive, you don't say, well, I'm buying stocks.
You say, I'm going long equities.
That's how you get attention at the finance professional singles bar.
Or not.
OK, now stock actually isn't one thing.
There is common stock.
When I say stock, I usually mean common stock.
But you've got to be a little careful about that because there are different flavors of
stock.
On the other side is preferred stock.
Preferred.
Now these are both equity.
So both of them have the residual claim to the cash flow.
In other words, liabilities have to be satisfied in their timely manner before any equity gets
a shot.
Gets some dividends or gets money plowed back into the company to increase stock prices.
However, within this equity, preferred has the prior claim.
So you have to satisfy the preferred shareholders before the common shareholders can get a dime.
Now common stock, for God's sake.
Now there's actually different flavors of common stock.
There is your, for lack of a better term, your standard or normal common stock.
The stuff that you see on the ticker symbols most of the time.
But then there are other kinds where there could be classified.
Class A, Class B, Class C, common stock.
Now the one that can get the most attention in this would be founder stock.
Founder stock is stock that was given to the founders.
It could also have been transferred to the founders to people early on or at some point
like that.
Now founder stock is subject to rule 144.
Founder stock is subject to rule 144 of the Securities Exchange Act of 1934.
It rules 144.
Sometimes we'll call it, well that's rule 144 stock.
Technically another term for it is restricted.
Back when stock certificates were actually printed, restricted stock would have restriction
in a stamp, red stamp right on the certificate.
What that meant was that unlike normal common stock, the holders of this restricted stock
couldn't just sell it whenever they wanted.
The rule 144 gives windows and other times when rule 144 stock can be released from restriction.
Like I'm the CEO of the company.
I have 10 million shares of the common stock of the company.
It's rule 144, it's subject to rule 144, it's restricted.
Now at certain times with the consent of legal counsel, I can leak some of that stock.
I can sell it.
This restricted stamp will come off.
You could actually buy stock from me during one of my windows and what you would get is
freely tradeable stock.
Your stock certificate would not have a restriction on it and I would have gotten it off my plate.
So rule 144 isn't a prohibition on sales.
It makes restrictions on the sales of the stock.
One of the things when I was a consultant, there were times when instead of being paid
in money, I was offered stock.
We'll pay you this.
Well that didn't do me a whole lot of good if I wanted to have dinner that night because
it would be rule 144 stock.
There's no question.
They were just handing it to me.
So it hadn't gone through a public offering or anything like that.
Another place where you'll see rule 144, before a company goes public, it can actually under
certain exemptions sell stock, but it has to be to special investors and it is restricted.
So restricted stock shows up.
It's not that unusual.
Now another interesting thing about it is there are websites where you can see insider
trading.
That is stock that is being released from 144 that's being dumped by the insiders of
the company.
So there's a kind of a mythical idea that, oh look, that CEO sold 50,000 shares of his
stock in the company.
That's a bad sign.
Not really, not necessarily.
I had a lot of companies where the insiders had started a company some years ago.
They had restricted stock.
The company was struggling.
They barely paid themselves enough to eat.
And so once the company got on its feet, then they used their abilities under rule 144 to
sell some of their stock so they'd have some money.
So it's not necessarily the case that just because you see insider stock sales that this
company is going to hell.
What you would be a little concerned about is if you saw a group of insiders all getting
rid of their stock at the same time.
That might be a little more of a, oh, that's the rats abandoning the ship.
Even then though, that's not necessarily the case.
But yeah, this restricted stock, it's just one of those things that's out there.
It's common stock, but it's common stock that is not freely tradeable.
That's just the bottom line of it.
And it can be released, sold, but only under certain conditions like times of the year
or like amounts maybe.
And you also have to have the legal counsel of the company say, yes, you can do this.
And then it's done.
I had a company.
They had some lawyer, he was really a dodgy fellow.
He would just sign off all the time on, yeah, this stock is released for 144.
Go ahead and sell it.
And so the CEO was just making scads of money by having all the stock they had given himself
when the company started and just dumping it out.
But anyway, okay, now, another thing is the founder's stock.
You have to be careful about classified stock because oftentimes classified stock will come
with certain rights that the normal common stock of the company doesn't have.
And I showed you this on one occasion and I'll bring it back up to you again.
My favorite example of this, Berkshire Hathaway has two classes of stock.
The baby Berks, Berk B's, it's just normal stock.
It's $336.90 a share, but it's just normal stock.
You get off there.
Okay, and you can see, you know, that's fancy.
You own a piece of Warren Buffett's company and all that good stuff.
So you can brag that, yeah, me and Warren are in investments together, all that.
But if you look at the big Berks, the BRK classified A's, well, those are the ones.
Right now you could pick up one share for $512,400.
Now I'm sure that many of you are saying, where can I buy this stock?
In other words, to own one share of this stock would cost north of half a million dollars.
It is classified A and that means it has, in this case, it has super majority voting
rights, super voting rights.
Instead of one vote per share for each director's position, you get a lot of votes per share
for each director's position.
And so you have a stronger control over the company.
Even owning one share, I'm not sure how many BRK A's are out there, but it is a ton of
them.
So buying one share, you really wouldn't have any control over Berkshire Hathaway.
Warren would make sure that he and his buddies have majority control over the board of directors
and they won't ever give that up.
But if you want to be in the big leagues, there you go.
If you've got half a million dollars you don't know what to do with, then buy one of these
BRK A's.
Or otherwise, talk to me.
I can make some suggestions about things that you could do with it and I'd help you spend
the money.
Okay, now, stock.
Suppose that you have a seasoned offering of stock, a seasoned offer.
In other words, it's already got stock outstanding.
One thing about common stock that I should bring up is what's called preemptive rights.
Preemptive rights.
Let's suppose there are, right now, outstanding, are 10 million shares.
And this is kind of a wild example.
10 million shares.
Okay.
Now, suppose that you own 1 million of those shares.
So your percent ownership in the company is 1 million divided by 10 million.
So you have a 10% stake in the company.
Now, suppose the company goes out and says, okay, we want to do a seasoned offering for
5 million shares.
So that would take the total outstanding of the company to 15 million shares.
But what that would do to you is it would bring, you still own a million shares, but
now you own a million shares on 15 million, which brings your stake down to 6.67%.
You've lost ownership position.
However, preemptive rights mean that as a stockholder, you have the right to preemptively
get shares, buy shares from this offering to bring your, to keep your stake at 10%,
or something better than what it was.
So in this case, what you would want to do is you would want to buy 500,000 shares.
You would have the right before anyone outside, you would have the right to preemptively say
500,000 of those 5 million, them or mine.
I'm buying them.
And that would take you up to 1,500,000, which for a stake would be 1,500,000 over 15 million.
And you'd be back to your 10% stake.
You'd be back to your 10% stake.
That's preemptive rights.
You have the right preemptively to keep your position.
Now, you could, while I don't really want 500,000 more, you could buy less, fewer than
that.
You have the right to buy up to 500,000, to subscribe, to subscribe for up to 500,000.
But you could subscribe to less, to fewer shares if you wanted.
That's preemptive rights.
Now, the last question in this regard is, do you want to do that?
Think about it this way.
I've done this one before.
This may sound like deja vu, but I'm repeating it here because we're hitting it for the last
time here.
You've got a company.
Now internally, many of you might very well be in the decision making process that leads
to deciding to offer common stock.
We need capital.
So why don't we sell stock to raise that capital?
Well the first thing is that usually the cost of equity capital is noticeably higher than
the cost of debt capital.
Why would a company raise money through selling stock when they could get a loan for what
they need at probably a better rate?
You'll see, I think it's next week or the week after that, maybe next, yeah it's next
week.
You'll see that you can have a cost of equity, do the calculation, might be like 18 percent,
but you could raise the money by issuing bonds at like 7 percent, 8 percent.
Why in God's name would you sell stock that costs more if you could sell bonds that cost
you less?
That's your first question.
Oh, you can't sell bonds, huh?
Because you're so deep that you probably, you have a high default risk and so you'll
pay coupons that are nosebleed on them.
Well there's a second question too, a little deeper.
Why'd a company, and I teach this in some courses, projecting what your stock price
will be based upon free cash flow projections and all that good stuff, I'll mention that
here today as a matter of fact.
If a company says, okay right now our stock is $20 a share, we're projecting that after
we release our earnings it's going to drop to $10 a share.
So what are you going to do when you decide when to sell common stock, to do that seasoned
offering of 5 million shares?
Are you going to decide, yeah we want to sell it for $20 a share, or no we want to wait
until we can get only $10 a share?
Most likely a company is going to sell its stock when it has determined in its best judgment
that the stock is near its peak.
And after that the stock price is going to fall because earnings announcements are something
like that.
So you are probably going to buy stock in a public offering when it is overvalued.
Because it's in the best interest of the company.
Oh it's overvalued so let's sell it now.
That's why preemptive rights might not be exercised.
You might see it that you are going to buy stock, you have the right to first dibs, but
you're going to be buying stock that is overvalued.
Whereas if you just waited, I mean you don't have preemptive rights anymore but you can
just buy it in the secondary market, when the stock price, if you like this company
so much, you can just buy it on your own later to bring your percentage ownership back up
to where it was.
So preemptive rights are not as glowing as they might sound at first.
It might not be a good idea to exercise your preemptive rights.
Because you're going to exercise them and buy stock that's overvalued.
How do you know it's overvalued?
Because the company is selling it.
That's why the company is telling you.
We think the stock is overvalued.
That's why we're selling stock now instead of six months from now when it's going to
fall below its intrinsic value.
So that's that little piece right there.
Okay, a few last things here.
Preferred stock.
And I've said this before, preferred stock used to be kind of popular but it's not really
popular anymore.
The cool thing about preferred stock is that you get the same dividend forever.
And you get your dividend before common can have a dividend.
So that's why it used to be kind of popular.
It was like a fixed income investment for older people maybe or for companies that just
didn't want price changes so much as they just wanted a fixed dividend that they could
use for projecting their investment income.
Let me show you one.
AZL, let's say, 1.75% cumulative, and I'll talk about that in a minute, preferred par
value $80 per share.
This means that forever, every year, you will get a 1.75% times $80.
You notice how this looks like a bond.
Coupon times face value.
Preferred stock works the same mechanical way like that.
So that you will get $1.40 per share forever.
That is a flat perpetuity.
And the formula for finding the present value, the price of a flat perpetuity, would be the
price now would be the dividend divided by the required rate of return of the market
on the stock.
So let's say that right now the market thinks that this dividend should be 2.0%.
Okay, just rock it through.
So in this case, the price of AZL preferred would be nothing but the $1.40 divided by
.020.
Very easy.
Just get this formula down.
It's so easy I don't even make a template for it.
That comes out to be $70 per share.
Yes, I made the numbers so that I don't have to use a calculator.
Notice something interesting.
The market's required rate of return, 2.0%, is higher than the coupon.
So the price of the preferred is below the face value, just like bonds.
It's the same mechanics.
Now if I'd had, let's say, a required rate of return of 1.5%, that would have been lower
than what the stock actually pays.
So this price would have been above $80.
Would have sold at a premium to the face.
Preferred stock is a joy.
It's easy to price.
As you saw in the last lecture, common stock can be an absolute bear to the horizon value
approach, the dividend growth model, CAPM use that to find a discount rate and all that.
In any way you cut it, it's going to be a pain in the butt.
Now one last pointer.
Technically speaking, the intrinsic value of the equity would be, technically, the sum
from i equals 1 out to infinity of the free cash flows per year, FCF sub i, divided by
1 plus the weighted average cost of capital to the i-th power.
In other words, the sum of the discounted values of the future free cash flows.
That's technically the value of a company, intrinsically.
Well that's good, but that means that you would have to project free cash flows from
year one out to year infinity.
And let me tell you, that can take a while.
Usually we go out to do this model, we'll go out maybe 10 years and say any free cash
flows after that, they're discounted so much that they really don't matter much anyway.
But even that isn't such a good idea because the farther out in the future you project
anything, the less certain you are about it.
So yeah, and I do this, I can show you, and I will if you take some of my higher level
courses which I'm sure all of you are saying, just so excited to do.
But I can show you how to project the cash free cash flows out as far as you want.
You build pro forma, we call them, financial statements, and then you grind them down through
that free cash flow formula, you know, the no pat plus depreciation minus capital expenditures
minus change in networking capital.
Yeah you can do it, but when you're projecting out that far, you might as well stop and just
call Madame Zabita's psychic hotline and ask her what it is.
It's probably better than some of us at projecting what it'll be.
Or you could use chat GPT and it'll just make up numbers out of nowhere and give you answers.
Let me show you one last, one little thing.
The book goes into this complicated formula for calculating what's called enterprise value.
This is one approach to finding the value, the intrinsic value.
And they go, and the book goes through this grueling, it's a pain in the ass to do.
This number and that number, return on equity minus, there's actually a shortcut.
The book mentions it, but how we actually do it, this is how we actually do it in real
corporate finance.
This way you go to a service like Standard Importers Global Net Advantage and you say,
okay, I can look up enterprise values for an industry, the average enterprise value
for an industry.
You just tell it, do an industry search, it'll give you all these numbers to find the enterprise
value.
It supports it by industry, by SIC.
And then you look down and you say, okay, now let's find the EBITDA, earnings before
interest and taxes, depreciation and amortization for the industry.
The numbers are right there.
Global Net Advantage gives them, there are other services that do it too.
And then you multiply that by the EBITDA of your company.
That gives you the enterprise value of your company.
It's much shorter way to do it than the formula that the book starts with.
The book ends with saying, oh, by the way, you could do it this way.
But this way is easier and I guarantee you that corporate finance jockeys are going to
use this every time.
Now you take the enterprise value divided by the number of shares outstanding and you've
got a decent picture of what the intrinsic value of each share is.
It's fast, it's dirty, and you can do it even as an outsider.
It's quick.
You just have to go in and get these numbers and you get the EBITDA just on the financial
statements of the company and then just divide by the number of shares outstanding and you've
got the intrinsic value per share.
Anyway, that's all I have for you.
You now have a quiz to take and when you're finished, you can go.
I thank you.