254 Chapter 6 Investments
also major stock exchanges outside the United States, in London, Paris, Toronto, and Tokyo,
for example, as well as many smaller exchanges both in the United States and outside. If a
company is listed on an exchange, the exchange maintains a market for buyers and sellers
of that stock to buy and sell its shares.
If you want to buy shares in a company such as, say, Walmart or Coca-Cola, you can
do that on any business day simply by opening a brokerage account and placing an order
to buy the shares on the open market. The stockbroker sends your order to one of the
exchanges, and, assuming shares are available for sale at a price you are willing to pay, you
can become an owner of part of the company. Shares can be sold just as easily. For large
companies whose shares are publicly traded, the fair market value is easy to determine—it
is simply the price for which shares are selling on the open market. You need only look at
what people who want to buy the stock have been paying people who want to sell it. Stocks
that can be readily bought and sold in the open market are often referred to as liquid. The
market prices of many large stocks can be found listed in most daily newspapers, and can
also be readily found online.Example 6.1.4 The market price per share of Zarofi re Systems is currently $49.75.
Calculate the stock’s dividend yield.The company is currently paying $0.45 per share quarterly (see Example 6.1.1). This works
out to a rate of (4)($0.45) $1.80 per year. As a percent of the stock price, this works out
to a dividend yield of $1.80/$49.75 3.62%.As in this example, most corporations in the United States pay dividends quarterly. Most
try to maintain a reasonably steady dividend rate, but the dividends paid can vary from
one quarter to the next. The dividend yield we calculated in this example was based on the
assumption that the dividend being paid in the current quarter would hold up for an entire
year. This is common practice in calculating dividend yields.
However, sometimes a dividend yield will be calculated on the basis of the total
dividends paid out by the company over the prior 12 months.Example 6.1.5 Zarofi re Systems has paid dividends totaling $1.75 in the past
12 months. Calculate the stock’s dividend yield.$1.75/$49.75 3.52%.When someone talks about a stock’s “dividend yield,” it is not always clear which of these
ways of calculating the dividend yield has been used. The term current dividend yield is
sometimes used for the yield calculated on the basis of the current dividend in distinction
from a trailing dividend yield based on the actual past year’s dividends. Unfortunately, this
distinction is not always clearly drawn in practice. Using these terms, though, we would
say that Zarofire Systems’ current dividend yield is 3.62%, and the company’s trailing
dividend yield is 3.52%.
Zarofire Systems is meant to be representative of the stock of a listed, openly traded com-
pany’s stock. Not all companies are listed, however. Smaller companies and other companies
whose shares seldom change hands would not normally be listed on a stock exchange, and
as a result it is not as easy to determine what price a share of such a stock could be bought or
sold for. Jason and Dave’s dry cleaning business is surely not listed on any stock exchange.
If you want to buy a piece of their company, you cannot do it by just contacting your broker
and placing an order. All of the shares of stock are owned by Jason or Dave; there is no open
market for shares of this corporation’s stock. If you wanted to buy stock in their company,
you would need to contact Jason or Dave and see if you can convince them to sell you some
of their shares. They may or may not be interested in selling. Likewise, if Jason or Dave
decides that he wants to sell his shares, he can’t do this simply by placing an order with the
neighborhood stockbroker either; he needs to find an interested buyer.
Stocks that are not readily available to be bought or sold are referred to as illiquid.
Determining the market value of an illiquid stock is more difficult than for a liquid one,
because there are no other open market sale prices to compare with. Companies (whether