## HOW TO INVEST IN STOCKSJUST LIKE WARREN BUFFETT

LESSON 24: PREFERRED STOCK BOOK VALUE WITH COMMON STOCK

## LESSON OBJECTIVES

1. Learn how to account for preferred stock on a balance sheet.
2. Learn what a 10-Q is.

## LESSON SUMMARY

As we learned in lesson 22, preferred stock holders own some of the equity in the company, but we also learned that it is equity that is treated differently in the event of liquidation than common stock equity. In this lesson we learn how to account for preferred stock on the balance sheet taking common stock equity into account.

Typically when you hear about book value, it is the book value per common stock, which is calculated as: Equity / common shares outstanding. This is a calculation that only holds true when there are no preferred shares. If the company you are analyzing has preferred share you should add that amount to the common shares outstanding. Simple math will tell you that the presence of preferred shares will dilute (decrease) the book value for the common stock.

This lesson also shows us that providers of financial information can mislead the investor with predefined values. For instance the pre-calculated book value per share on MSN money does not include the dilution from preferred stocks.

The 10-Q is also presented. That is the quarterly report that is sent to the SEC by the company. In the 10-Q is information like financial statements and other relevant date telling the investor about the financial situation in the company. The SEC filing is also where sites likes MSN money is finding the information to put on their site. However, just as explained this does not eliminate the risk of right information disclosed wrongly. The investor must scrutinize the SEC filing himself to gain certainty of the data.

Most often preferred shares are not a massive source of financing for companies. Often it may therefore not be perceived as having a real influence of the book value of the company. What is important to remember is how much of the company’s equity is currently financed by preferred shares. Perhaps even more importantly to understand how preferred shares and common stock are accounted for the balance sheet, especially in the event of a change in the capital structure. Although this might be a painful process for new investors, it’s importance is paramount. If an individual is interested in investing in such a company, you would need to assess this “correct book value” for previous periods in order to reasonably assess the common share holder’s equity growth in a business.

Common Shareholder’s Book Value = (Total Shareholders Equity – Total preferred stock par value) / common shares outstanding

When completing the equation above, you’ll want to ensure that you account for any cumulative dividend payments that haven’t been accounted for. For instance if a preferred stock is a cummulative asset, then all those dividend payments must be added to the par value. This total figure would then be subtracted from the total shareholder’s equity before dividing by the common shares outstanding.

Related Article: Preferred Stock and Book Value

## NEW VOCABULARY

10-Q
Quarterly information filed to the SEC about the finances of the company.

SEC
Short for U.S. Securities and Exchange Commission. Has the responsibility of enforcing and regulating laws for securities and exchange.

Financial Statements
Typically referring to the three main financial statements: Income Statement, Balance Sheet, and Cash Flow Statement. In theory it is a denominator for all formal records of financial information files by a company.

## LESSON TRANSCRIPT

In the 2 previous lessons, you were probably wondering how to account for common stock and preferred stock being on the same balance sheet. In some lessons from course 1, we calculated the book value of a company. Always do that whenever there are just common stocks for the company.

You need to know understand this lesson if you’re buying common stocks – to account the difference between common stock and preferred stock.

To demonstrate this, we will use SPG again. Go to MSN Money and type in SPG. You’ll see the common shares for Simon Property Group. Go to the common stock ticker, and to the balance sheet, because that’s where we’ll decide. We’re looking at the interim balance sheet for the first quarter of 2012. As we come forward, you’ll notice that the balance sheet is broken down into the assets and into the liabilities. The different between the two are about total equity.

We get the book value of the company by taking the total equity and dividing it by the total common shares, which gives us our book value. As we look at SPG’s balance sheet, let’s assume this company has no preferred stock. It just had common stocks. We take that 6000. I suggest you do your math at excel or anywhere easy for you. Take that 6077.91 divided by the total common stock which is 303.1. The results can be \$20.5.

Now, the balance sheet shows the common shares outstanding listed at 303.1, while the total preferred shares outstanding listed as .8. That is not being accounted for right there. That book value of \$20.5 is wrong.

You need to be careful when using the numbers from search engines. When they tell you ratios and numbers, you have to double check; especially when you’re not the one computing the balance sheet.

Here’s what MSN is showing the book value for SPG. Just so you know, Simon Property Group is a stock that I’m recommending. We use it, because it has preferred shares.

We go to the financial highlights. The book value is listed as \$20.5, which is exactly what we just calculated. The calculation here is wrong, and so if we look at that quickly and not actually check the balance sheet, we would be misled as what the book value of this company actually is.

In this case, let’s figure out the book value. Pull up what’s called the 10-Q – the quarterly report that the Simon Property Group would have to file to the Federal government to do their taxes. Go to the SEC filings and it pulls up all the documents that the SPG has. We’re looking for the 10-Q, because that’s the quarterly report. This would then be the raw information. MSN has pulled it from the report to make it easy for you to view. Go to the 10-Q report. You can see it’s the formal report that they had the file on whatever they have.

If you’re investing a lot of money in individual shares, become familiar with the 10-Q report. Read all the fine print where the best information is. Pick a part of all these tips that we’re giving you. The first thing they have here is their balance sheet. The assets are listed, the total liabilities, and the equity. The equity shows how much they value their preferred stocks. Right here, the numbers are in thousands. It’s 44.9 million. That’s what the preferred stock is listed at. We have to come into this report to find that.

To show the difference between the SEC filling report and the balance sheet that we were looking earlier, I pulled up side by side so you can see both. The total equity listed is \$6 billion. It’s all the same for the total stockholders’ equity.

Here’s where the preferred stock is listed at. The Par value for this is listed at the right side – 44.965. The balance sheet for the MSN version is 44.97. To know how much of the common share holders’ equity is, subtract that 44.97 from the figure. This shows you exactly the preferred stock that we’re looking at. In the previous lesson, they had 1 million shares initially offered. This is what they’re down to right now and the liquidation value is what they are currently listed at.

Let’s go back to our calculator. Subtract the equity of 44.97 from 6077.91 to get 6,000,000,032. In the end of the computation, it gives us \$19.09 – the bottom line figure. That’s the number we’re looking at for the book value on the common shares of SPG. Pay attention to that, unless you want to assess the equity growth of this business for the last ten years and see how much it has grown. You would know that from doing the intrinsic value calculation. Do the computation for each year to make sure you’re measuring the equity growth properly. Some might avoid buying common shares of a company that also had preferred stock out on it. That’s something you have to consider, because even though that’s about a difference of 15 cents, that could really have impact overtime.