why stocks go up and down

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QUIZ Answers

1. FALSE

Paying a dividend to common stockholders is something the board ofdirectors may choose to do with company earnings.It does not reduce earnings.

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2. TRUE

Earnings per share really means earnings per common share.Preferred dividends are deducted from earnings to get earningsavailable for common shareholders. This latter figure is divided bythe number of common shares outstanding to get earnings per share.This is covered in Chapter 12.

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3. FALSE

Retained earnings is one component of Ownership Equity. It cannotbe greater than Ownership Equity. See Chapter 2, where you will alsolearn about Paid in Capital, Additional Paid in Capital, and Commonat Par Value.

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4. TRUE

A primary offering just means the company is selling new shares. Aprimary offering may be the company's initial public offering, or itmay be the company's second public offering, or third publicoffering, etc. See Chapter 5 to learn the difference between a primaryoffering, a secondary offering, and an initial public offering. Also seequestion 5 below.

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5. FALSE

The word "secondary" is a source of confusion. A secondary offering, correctly speaking, isan offering of already outstanding shares, not new share. Therefore it would have no effecton the company, and would not be dilutive. Such secondaries usually reflect insider shares,or venture capital shares which have not yet been registered with the SEC, and are nowbeing registered and being resold to the public.

Unfortunately, the word "secondary" in recent years has also come to be used to mean anyprimary offering of new shares other than the initial public offering. With this improper useof "secondary" the correct answer to the question is True(because this is really a primary offering). This is initially confusing, but isexplained in Chapter 5.

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6. FALSE


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An IPO can also be a secondary offering. That is, the shares beingregistered and sold to the public are unregistered shares which arecurrently owned by company founders, venture capitalists, and thelike.

An initial public offering simply means that some of the company'sshares are being offered to the public for the first time. It makes nodifference whether these shares are primary (new shares beingcreated by the company), or secondary (already outstanding shares)which had not yet been registered.

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7. FALSE

Not necessarily. The price/earnings ratio is usually related to thecompany's growth rate. A company whose earnings per share aregrowing at 20% per year is likely to have a much higherprice/earnings ratio than a company which is only growing at only5% per year. The slower growing company might be a lot riskier.

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8. TRUE

Companies which have high depreciation and low earnings, forexample, may be better valued using a multiple of cash flow. SeeChapter 19, but please read Chapters 14 and 16 first.


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9. FALSE

They fall by half. This was an easy one.

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10. MAYBE

A stock split by itself does not change the value of anybody's stockholdings. See Chapter 6. But sometimes there is a psychologicaleffect which results in the stock rising slightly at about the time of thesplit, or when the split is first announced.

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11. TRUE

As long as the company has the cash, it can pay what it wants


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(usually). Can you think of two exceptions?

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12. TRUE

Capitalizing R & D costs means taking less expense that year, leavinghigher profit. See Chapter 15. Important if you follow companieswhich have a lot of R & D expense, such as software companies.

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13. FALSE

Accelerated depreciation is usually greater than straight-linedepreciation. Therefore, changing to accelerated depreciationincreases expenses, which lowers earnings. See Chapter 14.

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14. TRUE


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The increased depreciation expense will result in lower pretax profit,hence lower taxes, which will result in increased cash flow. SeeChapter 14. The difference between cash flow and earnings is a veryimportant concept.

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15. FALSE

Amortization is an expense. Increasing expenses lowerspretax profit.

Questions 12-15 are easy once these terms and concepts areexplained clearly. And you need to understand it if you wantto discuss investments at a professional level.

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16. FALSE

Bonds are safer because they are secured by specific assets as well asthe company's contractual commitment to pay interest and principal.Debentures are only backed by the latter. I can think of an exception.Can you?

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17. FALSE

Preferred stockholders are paid off ahead of common stockholders,but after all bondholders.

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18. TRUE

But when long term debt is much greater than equity, the companytypically has a low interest coverage ratio, which implies risk. SeeChapter 4.

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19. TRUE

The current yield is just the coupon (annual interest payment) dividedby the current price of the bond. The yield-to-maturity also considersthe coupon, but in addition, the yield-to-maturity adds the capitalgain the bondholder will have if the bond is bought below par andheld to maturity. If you want to understand the difference betweencoupon yield, current yield, and yield-to-maturity, read Chapter 9.


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20. FALSE

Return on capital is a profitability ratio. An increasing return oncapital implies improving profitability. The company is most likelybecoming less risky. See Chapter 4.

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THESE QUESTIONS WERE NOT REALLY HARD.READ THE BOOK.

YOU WILL LEARN ALL THIS, PLUS A LOT MORE.


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why stocks go up and down

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