An Introduction to Stocks OLAB
Professor Frank Howland
Two main perspectives
Four key ideas:
Owners hire managers to run the firm.
Managers want to maximize their income, while owners want managers to maximize the value of the firm. These goals can conflict.
Accounting firm audits and options were conceived as a way to align the interests of owners and managers. Auditors are supposed to ensure that management is telling the truth. Options were supposed to encourage managers to make the firm more valuable, because that would make the options valuable. However it has turned out that many managers made their companies' finances look better than they were in order to pump up the stock prices and thereby make the options valuable. Meanwhile accounting firms looked the other way. The latest twist on this story is that many firms granted options to executives by back-dating the options to dates when the price was especially low, making the options more valuable than they would have been otherwise.
The Market's Estimate of its Present Value
Basic Idea: A stock is worth the same as a bank account which will generate the same future cash flows.
A stock pays dividends of $5 per year and is expected to continue to pay the same dividend forever, with the first dividend coming one year from now.
A bank account pays 5% interest per year. The stock must be worth $100.
This is a present value computation. See PresentValue.xls
Remedy: Treat proceeds from stock buybacks like dividends.
The Market Map
The most important questions in finance:
Are markets completely rational, or can stock prices stray far away from reasonable values for long periods of time?
Can the irrationality of investors be predicted?
Are there more effective ways to deal with the owner-manager conflict?
Kansas, Dave, The Wall Street Journal Complete Money and Investing Guidebook. Three Rivers Press, 2005. This contains quick descriptions of markets and financial products.
Malkiel, Burton G., A Random Walk Down Wall Street, 8th Edition. W.W. Norton & Company, 2004. Perhaps the best introduction to stocks and investing.
Morris, Kenneth M. and Virginia Morris, The Wall Street Journal Guide to Understanding Money and Investing. Lightbulb Press, 1999. Another good guide to markets and financial products.
- Access to all sorts of financial data, some of which you have to pay for, but lots of which is free.
- Many different links to company and academic websites.
- This is the Securities and Exchange Commission data base of all reports that companies file with the Commission. The best primary source for information on companies.
- Quotes, charts, historical stock data.
One of the world's largest pension funds, with useful educational material.
A low-cost leader in the mutual fund industry.
Newspapers (available in print and on the internet)
Perhaps the best financial newspaper on the web. (You have to pay for this, but you can get a two-week free trial subscription.)
Not as comprehensive as the Wall Street Journal, but still useful. And largely free (after you register).