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Market for newly-issued
public for the first time. Some IPOs have proved very popular with investors. For ex-
securities, sold by the
ample, the star performer in 1999 was VA Linux Systems. Its shares were sold to in-
company to raise cash.
vestors at $30 each and by the end of the first day they had reached $239, a gain of
nearly 700 percent.
INITIAL PUBLIC Established firms that already have issued stock to the public also may decide to
OFFERING (IPO) raise money from time to time by issuing additional shares. Sales of new shares by such
First offering of stock to the firms are also primary market issues and are called seasoned offerings. When a firm is-
general public. sues new shares to the public, the previous owners share their ownership of the com-
pany with additional shareholders. In this sense, issuing new shares is like having new
partners buy into the firm.
Shares of stock can be risky investments. For example, the shares of Iridium were first
issued to the public in June 1997 at $20 a share. In May 1998 Iridium™s shares touched
$70; a little more than a year later, the company filed for bankruptcy and the shares were
no longer traded. You can understand why investors would be unhappy if forced to tie the
knot with a particular company forever. So large companies usually arrange for their
stocks to be listed on a stock exchange, which allows investors to trade existing stocks
among themselves. Exchanges are really markets for secondhand stocks, but they prefer
to describe themselves as secondary markets, which sounds more important.
SECONDARY MARKET
The two major exchanges in the United States are the New York Stock Exchange
Market in which already-
(NYSE) and the Nasdaq market. At the NYSE trades in each stock are handled by a spe-
issued securities are traded
cialist, who acts as an auctioneer. The specialist ensures that stocks are sold to those in-
among investors.
vestors who are prepared to pay the most and that they are bought from investors who
are willing to accept the lowest price.
The NYSE is an example of an auction market. By contrast, Nasdaq operates a
dealer market, in which each dealer uses computer links to quote prices at which he or
she is willing to buy or sell shares. A broker must survey the prices quoted by different
dealers to get a sense of where the best price can be had.
An important development in recent years has been the advent of electronic commu-
nication networks, or ECNs, which have captured ever-larger shares of trading volume.
These are electronic auction houses that match up investors™ orders to buy and sell shares.
Of course, there are stock exchanges in many other countries. As you can see from
Figure 3.10, the major exchanges in cities such as London, Tokyo, and Frankfurt trade
vast numbers of shares. But there are also literally hundreds of smaller exchanges
throughout the world. For example, the Tanzanian stock exchange opens for just half an
hour each week and trades shares in two companies.


READING THE STOCK MARKET LISTINGS
When you read the stock market pages in the newspaper, you are looking at the sec-
ondary market. Figure 3.11 is an excerpt from The Wall Street Journal of NYSE trad-
ing on February 25, 2000. The highlighted bar in the figure highlights the listing for
PepsiCo.2 The two numbers to the left of PepsiCo are the highest and lowest prices at

2 The table shows not only the company™s name, usually abbreviated, but also the symbol, or ticker, which is
used to identify the company on the NYSE price screens. The symbol for PepsiCo is “PEP”; other compa-
nies™ symbols are not at first glance so obvious.
282 SECTION THREE


FIGURE 3.10
Trading volume in major world stock markets, 1998

$8,000
$7,393
$7,000
Trading volume ($ billion)




$5,860
$6,000

$5,000

$4,000
$3,019
$3,000

$2,000 $1,589
$872 $717
$1,000 $681 $619 $504 $467 $429 $324
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Stock Markets




which the stock has traded in the last 52 weeks, $411„2 and $301„8, respectively. That™s a
reminder of just how much stock prices fluctuate.
Skip to the four columns on the right, and you will see the prices at which the stock
traded on February 25. The highest price at which the stock traded that day was $343„8
per share; the lowest was $333„16, and the closing price was $34, which was 3„16 dollar
lower than the previous day™s close.
The .54 value to the right of PepsiCo is the annual dividend per share paid by the
Periodic cash
DIVIDEND
company.3 In other words, investors in PepsiCo shares currently receive an annual in-
distribution from the firm to
come of $.54 on each share. Of course PepsiCo is not bound to keep that level of divi-
its shareholders.
dend in the future. You hope earnings and dividends will rise, but it™s possible that prof-
its will slump and PepsiCo will cut its dividend.
The dividend yield tells you how much dividend income you receive for each $100
that you invest in the stock. For PepsiCo, the yield is $.54/$34 = .016, or 1.6 percent.
Therefore, for every $100 invested in the stock, you would receive annual dividend in-
come of $1.60. The dividend yield on the stock is like the current yield on a bond. Both
look at the current income as a percentage of price. Both ignore prospective capital
gains or losses and therefore do not correspond to total rates of return.
If you scan Figure 3.11, you will see that dividend yields vary widely across com-
panies. While People™s Energy has a relatively high 7.0 percent yield, at the other ex-
treme, Perot Systems doesn™t even pay a dividend and therefore has zero yield. Investors
are content with a low or zero current yield as long as they can look to higher future
dividends and rising share prices.
The price-earnings (P/E) multiple for Pepsi is reported as 25. This is the ratio of
PRICE-EARNINGS (P/E)
the share price to earnings per share. The P/E ratio is a key tool of stock market ana-
MULTIPLE Ratio of
lysts. For example, low P/E stocks are sometimes touted as good buys for investors. We
stock price to earnings per
will have more to say about P/E later in this material.
share.

3 Actually, it™s the last quarterly dividend multiplied by 4.
Valuing Stocks 283


FIGURE 3.11
Stock market listings from
NEW YORK STOCK EXCHANGE
The Wall Street Journal,
COMPOSITE TRANSACTIONS
February 26, 2000.
52 Weeks Vol Net
Yld
Hi Lo Stock Sym Div % PE 100s Hi Lo Close Chg
151/8 111/4 121/2 127/16 121/2 1
MuniHldgCA II + /16
MUC .82e 6.6 ... 45
497/16 297/8 369/16 341/16 345/8 21/8
Pentair “
PNR .64 1.8 15 2098

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