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ARM > CH 10 Equity and property markets > Flashcards

CH 10 Equity and property markets Flashcards

1
Q

Why would a company buy back shares

A
  • Company has excess cash not being used profitably - returns to SH
  • Excess cash earning lower return than earned on company’s other assets. Getting rid of it should improve EPS for remaining shares
  • Tax efficient way of returning capital to shareholders
  • Change capital structure from equity to debt financing
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2
Q

Equities: investment and risk characteristics

A

Security

  • depends on issuing company
  • stability of company profits and earnings to dividends ration
  • if wound up - SH get residual assets

Yield: real vs nominal
- provide real yield over LT (profits tend to rise with infl)
- not guaranteed
Vs other assets:
- higher than bonds (more risk)
- margin depends on issuers of bonds and equity

Spread: volatility of capital values

  • Prices and div volatile
  • SP det by demand and supply
  • investors buy/sell on ST speculation
  • assess price as EPV of future dividends

Term: perpetuity

Expenses:

  • dealing costs linked to marketability (better for big companies/big issues)
  • larges expense in active trading is buy/sell spread
  • > bonds, depends on relative marketability

Exchange rate

  • equities available overseas
  • currency risk if have liabilities in domestic currency

Marketability

  • depends on company
  • usually larger company -> better
  • better for listed companies on recognise stock exchange
  • bad for non-listed exchange where owner must find another interested party

Tax
- Different tax for income and capital gains often

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3
Q

Compare listed and unlisted shares

A
  • to obtain listing, company must comply with stock exchange regulations that give consumer degree of protection
  • regulations usually relate to financial reporting and info disclosure
  • non listed equities - not same regulations - less consumer protection - more risky
  • listed generally more marketable than unlisted thus easier to value
  • great divisibility
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4
Q

Equity categorization: why do analysts specify in a certain equity industry

What are factors affecting companies in same sector

A
  1. Practicality
    - factors affecting comp in one industry relevant to others in industry
    - common info sources for companies in same industry, similarly presented
    - can’t be expert in all areas
    - Grouping equities to common factor gives structure to decision making process. Assists in portfolio management
  2. Correlation of investment performance
    - SP movements correlated in industry groups
    - movements reflect changes in operating environment
    - affect companies in industry similarly, so listings divided into sectors
    FACTORS AFFECTING COMPANIES IN SAME SECTOR:
  3. Resources: similar input, costs
  4. Markets: supply to same markets, similarly affected by demand changes
  5. Structure: similar financial structure, similarly affected by interest rate changes
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5
Q

Give problems with industry groupings

A

Difficult to group companies to specific industry because

  1. There are companies that operate in several sectors (conglomerate companies)
  2. There is still heterogeneity of companies within a particular sector (size, operate in different focuses of market)
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6
Q

What determines the level of equity market

A

EXPECTATIONS OF FUTURE PROFITABILITY

as Equity price = EPV of future dividends

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7
Q

List the economic factors affecting level of equity market (ie affecting expectation of profits)

A
  1. Expectations of real interest rates
  2. Expected inflation (market usually indifferent, but does have indirect effects)
  3. Equity risk premium - extra return investors require from equity over rfr
  4. Expected real economic growth: (as investors want dividends to grow in line with real economic growth)
  5. Exchange rates (relates to imports/exports and profitability)
  6. Demand changing factors (change to tax laws, institutional flow of funds, alternative investments)
  7. Supply changing factors (Number of rights issues, share buy backs, privitisations)
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8
Q

List some indirect effects of inflation on level of equities markets

A
  1. Bad for economic growth
  2. Investors expecting high inflation expect gvt to increase real rates in response
  3. High inflation - more uncertainty about future inflation - not as keen on FIB. Equities more attractive as they give inflation protection. Demand for equities go up.
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9
Q

Give the effects of weak domestic currency on level of equity market by reference to imports and exports

A

Weak domestic currency

EXPORTS
- increased exports (we offer cheap)
- profits for export goods and serivices increase
RETURN ON FOREIGN INVESTMENT
- returns earned in other currencies high when converted to domestic currency

IMPORTS

  • more expensive imports
  • lower profits if company can’t increase prices to compensate
  • reduced importing - increased business for local suppliers of product
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10
Q

Give characteristics used to define prime property

LATSLS

A
  1. Location
  2. Age and condition
  3. Tenant quality
  4. Number of similar properties to help determine rent at rent review for valuation purposes
  5. Lease structure
  6. Size
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11
Q

Give disadvantages of direct property investment

SiDiMVE

A
  1. Size: too big to afford
  2. Diversification (linked to size) - many properties needed to have well diversified portfolio
  3. Marketability (lack) time taken and costs when buying and selling make unmarketable
  4. Valuation - values not known until sale. Estimates expensive
  5. Expertise needed - much of profit to be made from property comes from detailed local knowledge
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12
Q

Investment characteristics of property:
SECURITY, risks
VOG

A

Rental income security depends on tenant
- Risk of voids:
no tenant, no income. Must allow for this when estimating expected returns on property

  • Risk of obsolesce:
    Building outdated, no use to potential tenants
    Deteriorate and depreciate over time: val of prop fall in real terms
    High cost of refurbishment and modernization

(Securities dont have that high cost)

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13
Q

Discuss yield on property: real vs nominal and compared to other assets

A
  1. LT real returns. Doesn’t have exact inflation hedge, rent expected to increase BROADLY in line with inflation.
  2. Comp to other assets
    Higher than ILB

Factors to consider in differences in return:

  1. P doesn’t have exact inflation hedge
  2. High buy/sell/manage costs than portfolio of ILB
  3. Individible
  4. Risk of obsolesce/depreciation
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14
Q

Discuss the spread/volatility of capital values for property

A
  1. Volatile capital value over long term
  2. Infrequent valuation and stable valuation methods decrease ST volatility
  3. Land indestructible - always has some value
  4. Property vals move in cycle, lag behind economic cycle as supply is slow to respond to economic changes.
  5. Vals usually determined by expected rental inflow which is relatively stable
  6. Property value more secure if site value is large proportion of capital value
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15
Q

Discuss the term and cost of Dir prop investment

A

Long term commitment
High maintenance costs
Tenant often responsible for insurance and building maintenance

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16
Q

Why is property unmarketable (UUV)

A

Unmarketable due to high dealing costs and time taken to buy and sell.

This is due to:

  1. Unit size: large, usually indivisible
  2. Uniqueness: each prop unique difficult to value
  3. Valuation
    - Subjective, professional judgement
    - Expensive
    - Only know true market value on sale
    - No central market with quoted property prices
    • Lack of info: infrequent and confidential sales
      - Different valuation bases
17
Q

Risks associated with investing in property development

A

Additional risk with building and establishing a new property

  • delays in time to completion
  • overrun in estimated building costs
  • time to find a tenant at expected rental income when finished

Thus investing in property development requires higher yield compared to existing established buildings

18
Q

Explain ways of gaining indirect property investment

A
  1. POOLED PROPERTY FUNDS
    • open ended unitised fund
    • closed ended investment trust company
      Usually have rules specifying type of property can invest in, liquidity requirements, management charges that can be deducted from fund
  2. PROPERTY COMPANY SHARES (also get exposure to property development and existing property)
    - can be property developers or property investors

LISTED JSE REITS

  • Real Estate Investment Trusts
  • Companies that manage, operate and own portfolio of income producing properties
  • Divided into Trust REITs and Company REITS
  • Strong legislation applicable to each
19
Q

Define NAV and why property shares sometimes are at discount to NAV

A

NAV P/S - represents companies wind up value per share
NAV = (ASSETS net of liabilities and intangible assets)/#Shares

Discount to NAV reflects:

  1. differences between how investors value shares and propery
  2. risk of loss on forced sale - CF requirements result in property companies being more likely to be forced sellers of property than institutions when undertaking direct property themselves

When is discount possible:

  1. Market has positive views of development (capital gain potential)
  2. Conservative valuations underlying NAV
  3. Property company has good management track record
20
Q

What are the three main areas where economic influences affect property market level
(ODI)

A

OCCUPATION:
- Demand for rental space

DEVELOPMENT CYCLES
- Supply of completed property
(interaction between occupational supply and demand determine market level)

INVESTMENT MARKET
- Supply and demand for properties as investments
(determines capital value of rented property - reflects market level of rent income)

21
Q

Discuss factors influencing OCCUPATIONAL demand for rental property
(ES)

A

ECONOMIC GROWTH

  • Demand linked with GDP growth (consumer expendit, employment levels)
  • Factors affecting economic growth will affect demand for property
STRUCTURAL CHANGES in demand for property
New trends in economic activity
 - offices moving to cheaper areas
 - working from home
 - online shopping
22
Q

Discuss factors affecting DEVELOPMENT CYCLES (supply of property) in affecting level of property market and INELASTICITY OF SUPPLY

A
  • Long time taken to develop causes supply lags
  • Supply INELASTIC: when demand change, supply can’t quickly change with it. If demand increases, takes long to develop to reach supply needs
  • When supply doesn’t match demand - property prices volatile
  • Authorities may restrict development, restricting supply
  • Property use may be legally controlled (affecting demand)
23
Q

Discuss PROPERTY INVESTMENT MARKET, and how it affects property levels
(Infl, real interest rates, other factors)

A

PROPERTY INVESTMENT MARKET RELIES ON OCCUPATION MARKET (provides investment income, rental growth prospects)

INFLATION

  • Erodes real value of rent inc if infrequent reviews (ST)
  • Infrequent rent reviews: property prices should fall if high inflation (ST)
  • Property provides good inflation hedge in LT

REAL INTEREST RATES

  • Property value EPV rental income
  • High real int rates - lower PV - Lower val of property
  • ST: unclear relationship between interest rates and property yields
  • LT: high LT bond yields - decr demand for property investment - lower prices of peoperty investment value
OTHER FACTORS
Other sources of investment 
  - Institutional investors
  - Public/private companies using bank debt 
  - International investors
Exchange rate affects overseas investors

Property prices behave like bond prices

24
Q

Explain what can affect values of residential property

A

Values usually bought using mortgage.

Demand:
- Individuals may not be ab le to take out high enough mortgage if their earnings are very low compared to property prices
+ But continual demand for housing as people always need place to live (rental levels driven up continuously)
+ Affected by interest rates: if interest rates low, property from increasing rental income more attractive investment

Supply:
- state can constrain new developments in high demand areas

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