CH 10: Equity and property markets Flashcards
Ordinary Shares
3
- Ordinary shares are securities held by the owners of an organization
- Ordinary shareholders have the right to receive all distributable profits of a company after debtholders and preference shareholders have been paid.
- They also have the right to attend and vote at general meetings of the company
Describe the cashflows on an ordinary share from the perspective of the investor
3
Share purchase:
- An initial lump sum negative cashflow equal to the price paid for the share plus dealing expenses
Dividend payments:
- A regular series of positive cashflows representing a share in the company’s profits
- The timing of these payments is generally known
- The amount is unknown and variable
- Over time profits, and hence dividends, and expected to increase broadly in line with growth in GDP
- The company may choose not to distribute all of its profits but to retain some for new projects, expansions or to subsidize dividends in poorer years.
Final payment:
- There is no redemption payment – dividends can be assumed to continue indefinitely
- However, there will be a final positive cashflow, which is unknown in amount and timing if:
1. The investor sells the share, or the company buys it back
2. The company winds up and there is residual funds to distribute
DIV payout = DIV/EPS
Investment and risk characteristics of equities
- S: Depends on profitability of the company, wound up receive residual assets
- Y: Provide a long-term real yield as company profits grow in line with inflation/GDP
- Y: Higher expected returns than government bonds over the long term
- S: Dividend and market values (supply and demand) can be volatile
- T: Equities can generally be held in perpetuity
- E: Dealing expenses are linked to marketability, main is bid-offer spread
- E: Currency risk if internation equity
- M: Marketability depends on the size of the company. Larger better.
- T: Income + CGT
Quoted/ Listed shares
1,5
- Shares of companies listed on a stock exchange, make up the majority of available equities.
Companies listed meet exchange requirements so listed shares are:
* Highly regulated - more security
* More marketable
* More divisible
* More info available
* Easier to value
Categorisation of shares by industry
4,3,2
Practicality:
* Most companies within an industry are affected by similar factors
* The info comes from a common source and is presented in a similar way
* No-one can be an expert in all areas
* It adds structure to the decision-making process
Correlation of investment performance: (due to factors affect all companies)
* Resources: Similar resources used. (similar input costs)
* Markets: Supply same markets.(similar affect to change in demand)
* Structure: Financial structure same(affected same to change of interest)
Problems with grouping:
* Companies operate in multiple sectors
* Heterogeneity of companies within sector
- share prices of companies in the same sector tend to be correlated
Preference shares
1,3
- A particular class of share that generally ranks ahead of ordinary shares.
Normally entitled to a specified rate of dividend, and, unlike ordinary shareholders, not to residual profits.
Features:
* dividend on a preference share is usually a fixed percentage of the par value and is always paid before any distribution to ordinary shareholders.
* Dividends don’t have to be paid if profits are insufficient, arrears paid off next payment of dividends before ordinary.
* No voting rights
Cumulative property of pref shares
Reasons for buying back shares
4
- Excess cash that cannot be used profitably and is
returned to shareholders - Excess cash may only earn deposit rate of interest,
thus improves earning per share for remaining shares - May be more tax-efficient than dividends
- Company may wish to change capital structure from
equity financing to debt financing
Characteristics of Property
- S: Depend on tenant riskiness. Old- no income generated (Obsolescence risk)
- Y: Real returns generated, hedge for inflation
- Y: Expect higher returns ( less marketable and secure)
- S: Capital values can be volatile. Cycles
- T: MT/LT (high transfer cost)
- E: High. Management and maintenance
- E: Currency risk if international
- M: Unmarketable(Not divisible, unique assets, subjective valuation)
- T: Income + CGT
Advantages and disadvantages of direct property investment
5,4
Advantages of direct investment:
- Diversification of overall portfolio
- Less volatile than property shares
- Control over property portfolio management
- Loss on forced sale unlikely
- Exposure (property company may invest in buildings under construction, multiple risks associated)
Disadvantages of direct investment:
* Afforadability: too expensive for single investors
* Low marketability: High costs buy/sell
* Subjective valuation: not known till sale
* Expertise needed: To generate profits
Indirect property investment
2,4
Investment via:
* Shares in property companies
* Units in a pooled property fund: Open-ended unitised fund / closed- ended investment trust
R-E-I-T-S: real estate investment trust/company
* Own, manage, operate real estate portfolioof rentals.
* Able to invest in large property/ developments
* Listed on JSE, shares traded
* Exposed to development/expense/tenant risks
Advantages of indirect property investment
- Diversification within the property market (property companies offer greater spread of risk)
- Market prices / performance measurement - no visible market price for real property.
- Marketability - property shares are more marketable than direct investments.
- Management expertise (company can afford expertise)
- Advantage of size (large companies may invest in large properties, too big for direct investors)
Disadvantages?
NAV
2
- NAV = ASSETS/#Shares share value discount or premium
- Property shares usually stand at a discount to NAV due to subjective value of properties
Property assets may be purchased cheaply.
Prime property
Property most attractive to investors. Score highly on: S - Size T - Tenant quality A - Age & condition L - Location L - Lease structure
C - Comparability
Investment and risk characteristics of property to be considered:
M-Marketability
U- Uniqueness
S- Size
T- Type of Property (determines the running yield)
P- Political Risk R- Real long term RETURNS (property is a real asset) O- Obsolescence V- Valuation I- Indivisibility D- Diversification E- High Management and dealing EXPENSES
F- FORCED sales
I- stepped INCOME stream
V- Volatility
E- Expertise available
What to consider when comparing direct to indirect property investments:
C- Control
E- Expenses
D- Diversification
E- Expertise
M- Marketability
E- Exposure to other sectors
E- Equity correlation for instance
T- Taxation
Volatility
Valuation
Gearing
Forced Sales
