Company are an asset, usually termed Marketable Securities.To the investor, the current market value of securities owned is far more relevant than the original issue price or than the securities’ par values or book values.
The market value indicates what the securities are worth today. Changes in market value directly affect the investor’s solvency, financial position, and net worth.Not these reasons, investors show investments in marketable securities at current market value in their balance sheets. Because market prices are of such importance to investors, we will briefly discuss the factors that most affect the market prices of preferred and common stocks.
This market price may differ substantially from such amounts u par value, the original issue price, and the current book value. Which 1s the vant amount? That depends on your Ps»tlt of view . After share. are issued, they belong to the holder, not to the issuing corporation.
Thus changes in the market price of these shares affect the financial position of the stockholder. but not that of the, issuing company, This concept explains why the issuing company’ and ‘stockholders apply very different accounting principles to.tne same outstanding shares.
Accounting by thal saur From the viewpoint of the issue’s company, outstanding stock represents an amount invested in the company by its owners at a particular date.
While the market value of the stockholders’ investment may change, the amount of resources that they originally invested does not Thus the company issuing stock records the issue price-that is. the proceeds received from Issuing the stock in its paid-in capital accounts.
The balances in these accounts remain unchanged unless:
(1) more shares are issued or
(2) outstanding shares are permanently retired (that is, preferred stock is called).
Market Price of Preferred Stock Investors buy preferred stocks primarily to receive the dividends that these shares pay. LO 6 Thus dividend rate is one important factor in determining the market price of preferred
Discuss the factors affect Citing stock. Another important factor is risk. In the long run, a company must be’ profitable the market price of preferred enough to pay dividends. If there is a distinct possibility that the company will not op- stock. and common storage profitable and pay dividends, the price of its preferred stock will decline. A third factor greatly affecting the value of preferred stocks is the level of interest ,rates.
‘What happens ·to the market price of an 8% preferred stock, originally issued at a par value of $100, if government policies and other factors cause long-term interest rates .to rise to, say, 15% or 16%? If investments offering a return of 16% with the same level of risk are readily available, investors will no longer pay $100 for a share of preferred stock that provides dividend of only 8 per year.
Thus the market price of the preferred stock will fall to about half of its original issue price. or about $50 per share. At this market price, the stock offers ‘a 16% return (called the ‘dividend yield) to an investor parasympathetic stock, however if the prevailing long-term interest rates should again decline to the 8% range’, the market-price of’ an 8% preferred sleek should quickly rise to ‘approximately, pat value. 1 summary. the market preferred stock’ varies inversely with interest rates.
As interest rates rise, preferred stock prices decline;.as interest rates.fall, preferred stock prices rise. Market Stock Reva lig interest rate; also of common stock.
How demands, common stockholders !ire 9.0t fixed. amourt.: Both the amount of the Margrethe) may increase dramatically if the corporation tertiarily. the company ‘is unsuccessful, the common stockholders may not even recover their original investment. Therefore most important factors in the market price of Common stock are investors’ expectations as to the future profitable the business and the risk that this level’of profitability may not be achieved; Bear in mind that after shares have been .issued they belong to the stockholders. not to the issuing corporation, the market place of to shares .do hot affect the financial statements Of the corporation, and these ‘Changes are not recorded in the corporation’s accounting rods. The I2aid~incapital shown in (J corporate balance sheet represents the amount received ‘when the .st-ck was issued, not current market value of shares.’Book Value and Market Price.
To some extent. book value is.used in ‘evaluating the reasonableness of the market price of a stock. However,’ it must be used with’ great ‘caution; ~ fact. that ‘a stock Is selling . at less than book value does not necessarily. iicate a bargain Book value is a historical concept. representing the.amounts ‘invested- by stockholders plus the amounts earned anp retained by the corporation. If a stock is selling at n” price well above book value, investors believe that management has created a business worth substantially more than the Historical cost of the resources entrusted to its care. This in essence, is the sign of a successful corporation “. If the excess of ‘market price over book value becomes very great. however, investors should consider whether the company’s prospects really market price so much .above the underlying book value of the company’s resources. .
On the other hand, if the market price of a stock. is less than book value. investors’ .believe that the company’s resources are worth less than their cost while under “the control of current management, Thus the relationship between book value and market ‘price is one measure of investors,anv’s management