Asset Classes 4 - Equities(b)

Question 1

What is the formula of the dividend valuation (Gordon growth) model?

Answer 1

Share Price = Dividend / ( Return required − Dividend growth )

Question 2

What is the formual for dividend yield?

Answer 2

Gross Dividend / Current Share Price

Question 3

What is the formula for EPS?

Answer 3

Profit attributable to ordinary shareholders / Current Share Price

(Profit = net profit after taxes and preferred dividend / no of shares in issue)

Question 4

What is the formula for Earnings Yield?

Answer 4

EPS / Price per share

Question 5

What is the formula for PE ratio and what does it tell you?

Answer 5

PE = Price per share / EPS

• A high P/E ratio may indicate a relatively low perception of risk, or an expectation of good profits growth. Alternatively, it could mean that the share price is high relative to the company’s earnings and the shares are possibly overvalued.

Question 6

What is the formula for Price Earnings Growth (PEG) and how is it used?

Answer 6

• PEG ratio = PE ratio / EPS growth rate
• =1 a perfect correlation between the market value of a company and its projected earnings growth.
• > 1 stock is overvalued; <1 stock is undervalued

Question 7

What is the formula for Dividend Cover?

Answer 7

Dividend Cover = EPS / DPS

Question 8

What is the formula for Price-to-Cash Flow (P/CF) Ratio and how it is interpreted?

Answer 8

P/CF Ratio = Price per share / Operating Cash Flow per share

This measure assesses the market’s expectations or prospects about a company’s financial health.

Question 9

What is the formula for the Price to Book Ratio and its uses?

Answer 9

P/B ratio = price per share / book value per share (BVPS)

• BVPS = common equity divided by its number of shares outstanding.

Used for banking sector

Question 10

What is the formula for the Enterprise Value and its uses?

Answer 10

EV = Market cap + Debt − Cash − Cash equivalents

It is considered a theoretical measure for the cost of takeover.

Question 11

What is the formula for the Return on Equity and its uses?

Answer 11

ROE = Profits after tax and dividends / capital and reserves (shareholders funds)

ROE measures the percentage return that the company is achieving on the amount of funds provided by shareholders,

Question 12

What is the formula for the Return on Capital Employed and why is it better than ROE?

Answer 12

ROCE (%) = Profit before interest and tax / Capital Employed (= total assets + current liabilities)

• ROCE is a better comparison between companies than ROE, since ROE is heavily affected by differences in the capital structure of companies

Question 13

What are the 2 gearing formulas?

Answer 13

1) Gearing (%) = Long -term liabilities / Capital Employed

2) Gearing (%) = Earnings before interest and tax / Interest payable

Question 14

What is the formula for the Working Capital (CURRENT) Ratio and its uses?

Answer 14

Current ratio ( x ) = Current assets / Current liabilities

• The purpose of this is to determine if the current assets recoverable within one year are sufficient to cover the liabilities that fall due within that year. A NUMBER BETWEEN 1.5-2 IS ACCEPTABLE

Question 15

What is the formula for the Quick (ACID TEST) Ratio and its uses?

Answer 15

(Current Assets - Inventories) / Current Liabilities

• Measures only those assets which can be quickly and definitely turned into cash.
• A higher quick ratio indicates that the company could pay off its current liabilities several times over.
• If the ratio is below 1, then the company may find it difficult to raise cash to pay its creditors if it suffers an interruption.

Question 16

What are the 9 Active Equity Investing Strategies?

Answer 16

• Growth investing – focuses on companies that are able to differentiate their product/ service from their industry peers so as to command a competitive advantage.
• Growth at a reasonable price (GARP) investing –companies that are perceived to offer above-average earnings growth potential that has yet to be fully factored into the share price.
• Income investing – aims to identify companies that provide a high, steady stream of safe, reliable income. I
• Value investing – seeks to identify those established companies, usually cyclical in nature, that have been ignored by the market but look set for recovery.
• Blend investing – combines growth and value investing, thus offers the potential benefits and risks of both styles.
• Contrarian investing – the market has overreacted to a particular situation
• Absolute return investing – seeks to generate positive returns in all market conditions.
• Quantitative investing – uses computers to find predictable patterns within financial data
• Long/short – buying long equities that are expected to increase in value and selling short equities that are expected to fall in value.

Question 17

What are the 6 Indexation Strategies?

Answer 17

• FULL REPLICATION (also duplication or complete indexation) – an investor holds all constituents of an index, weighted according to their relevant market proportions.
• STRATIFIED SAMPLING – holding a sample of securities from each sector within an index, which is representative of the characteristics of that index.
• FACTOR MATCHING – selecting securities based on specifically chosen factors or risk characteristics (eg, sector breakdown, firm size).
• OPTIMISATION – using sophisticated computer modelling to build a portfolio, by finding holdings that broadly mimic the characteristics of the index.
• SYNTHETIC – involving the investor entering into swap agreements, either with one or multiple counterparties, to track the return of a benchmark index.
• REBALANCING – the weightings are periodically realigned since the optimal proportion that an investor has selected is not maintained over time.

Question 18

What are Smart Beta ETFs?

Answer 18

ETFs that aim to generate alpha (ie, excess returns above a benchmark index) by passively following that index, while also considering alternative weighting schemes (eg, volatility, liquidity, quality, value, size and/ or momentum)

Question 19

What are the listing requirements for the LSE main market?

Answer 19

• minimum market capitalisation of at least £30 million (of which no less than 10% must be made freely available to the investing public)
• trading history of at least three years

Question 20

Which ratio is useful for takovers and why?

Answer 20

• NAV/share
• to see whether the share price represents a fair value for the assets they will acquire and how much they will be paying as a premium for goodwill.