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KR editions 140 to 142

KR-140 : Par=Nominal=Face!

Hi everyone,

Going back to our balance sheet...

On the balance sheet, we'll find something like capital stock and additional paid-in capital. These 2 rows will come on the right side of the balance sheet; i.e. under the LIABILITIES and EQUITY section.

Capital stock is the amount paid by investors to by stocks at a par value. What's a par value?

Par value or face value or nominal value is the value of the stock as printed on it.

• Face value doesn't apply to stocks alone. It applies to bonds, fixed deposit certificates etc. as well. In fact it is more relevant with regard to bonds than stocks.

• When we buy a bond (say a tax saving bond) issued by a bank; we get a bond certificate stating the value of the bond (this will be written on the certificate).

• The bond may be worth \$100. This is the par value (or face value).

• In effect the bank says that "You have bought a \$100 bond from me and I shall pay you back the amount after 5 years when you return this certificate. I shall also pay you an interest of 5% on the par value of the bond".

• So the bank has a liability to repay the buyer when he/she returns the bond. We buy bonds generally since they provide a higher interest rate (or they help save tax) and these interest rates will be quoted as a percentage of the par value.

What's the par value for a stock?

• Companies usually (and legally are allowed to) set the par value of the stock to a bare minimum (sometimes it is even permitted to issue stocks with no par value!).

• For instance our whiz kid's company might issue 1000 stocks each with a par value of just 1 cent!

• But the very purpose of issuing stocks to the public is to raise a lot of money; if they sell stocks for 1 cent then they'll only collect \$10, right? Not exactly since the selling price of the stock will be much higher than the face value of the stock.

• Our whizkid's company might be doing very well and investors might be willing to pay \$100 for a stock. So even though the par value is \$0.01 the company actually raises \$100 per stock (of course the selling price of the stock depends on how well the company is doing and how much investors are willing to spend to buy the stock).

Food for thought: Why shouldn't our whizkid set the par value as \$100 itself?

KR-141 : Par II

Continuing where we left off in par value.....

Par value of a stock really doesn't really have much importance except when it comes to paying out dividends.

Consider the case below:

• A person buys 100 stocks of our whizkid's company. Each stock has a par value of Rs.1 but the market price was Rs.100. So the person has actually spent Rs10000 to buy the 100 stocks.

• When the company announces that they are paying dividends of 50%, our investor might think "Wow; I'll be getting a Rs. 5000 this year!".

• Right? Well, it's wrong. Generally a company announces dividends as a percentage of par value. So our investor would actually get: Rs. 50!

• And actually it makes sense since market value is something which varies every day (or even every hour) and so the company cannot announce a dividend based on the market value.

• Now one might wonder why do we have to spend money on stocks if we gets such low dividends.

• Actually investors don't really expect to earn much out of dividends (in fact some companies might not give dividends yearly).

• Investors hope to make money using the other option (remember capital gain; which we discussed in an earlier KR).

• So coming back to our discussion on par value. For stocks, if the market price falls below the par value, theoretically we could say that the company has a liability.

• Ex: If the company issues 1 stock with par value of \$10 and if the market price drops to \$1 then theoretically we can say that the company has a liability of \$9. But it really doesn't mean that the person holding that 1 stock can claim to get \$10 back from the company!

Hope you are clear about par/face value now.

KR-142 : Back to Balance sheet!

Going back to our financial statements.....

What is common stockholder's equity?

This is called called the net worth of a firm. Basically it refers to the capital supplied by the common stockholders - which when mapped to the balance sheet means: common stock + retained earnings.

Another calculation from our balance sheet equation is:

ASSETS = LIABILITIES + EQUITY       or

EQUITY = ASSETS - LIABILITIES - preferred stock (we'll see this component later) or

NET WORTH = ASSETS - LIABILITIES - preferred stock

Why would an investor be worried about this "net worth"?

It just indicates that "If this company had to immediately pay out all its liabilities then it would need to sell off its assets. So after selling the assets and paying the liabilities how much will the company be left with?"

Preferred stock - preferred stock lies somewhere between a loan and a common stock.

If an investor owns a preferred stock then the investor is guaranteed a fixed amount of dividend every year.

When dividends are paid out, preferred stock owners will be paid out first and only the left over amount will be paid out to common stock holders.

Preferred stock is not that common...which is why it isn't called common stock! :-) (and common stock refers to the normal stocks we've discussed up to now)....we'll see some differences later.

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