Chapter 10: Equity Flashcards
What does the term ‘ordinary share’ mean?
> Securities held by owners of an organisation
Right to receive all distributable profit (dividends)
After debtholders and preference shareholders have been paid
Attend and vote at the AGM of the company
SYSTEEM T – ordinary shares
See below
Security (default risk)
Security of the dividend will depend on the company issuing the shares
> In particular it will depend on the stability of the company’s profit and dividend cover
> If company is wound up, shareholders will receive the residuals after assets after all creditors have been paid
Yield - real vs nominal
Historically, equities have provided a real yield over the long term
> Because, company profits tend to rise with inflation and economic growth and hence dividends
> Hedge is a loose one, no guarantee of inflation protection
Yeild - expected return relative to other assets
Equities are perceived to be more risky than bonds and would be expected to give a higher return to compensate
Spread - volatility of capital values
Both equity prices and dividends can be volatile
> Price is of individual equity share is determined by interaction of supply and demand
> Short term speculation < present value of future dividends
Term
Equities can be generally held in perpetuity
Expenses
> dealing costs are closely linked to marketability
they are generally greater than for bonds, but depends on relative marketability of the stocks being compared
Exchange rate - currency risk
Equities are available in many overseas countries
> Currency risk for an investor who is investing in equities denominated in one currency but has liabilities denominated in another
Marketability
Varies enormously between companies
> Larger companies in general have the better marketability
> Poor marketability - not listed on any recognized stock
Tax
Income and capital gain from unquoted and quoted shares may be taxed differently
Different investors will pay differing tax rates
What are the cashflows of an ordinary share from the perspective of the investor?
> Share purchase=> outflow of the market price of the share + dealing costs
Dividend payments=> Regular series of positive cashflows representing a share of the companies’ profits. Timing is generally known. The amount is unknown. Profits are expected to increase in line with GDP. Company may retain some profits for new projects expansion or to subsidise dividends in poorer years.
Final payment=>No redemption payment. Dividends assumed to continue indefinitely. There might be a final value if:
i. the Investor sells his holdings OR
ii. the company buys it back
iii. Or the company winds up and there is residual funds to distribute
What are the advantages of listed shares to the investor over unlisted shares?
> Greater marketability
Easier to value
Greater security (stock exchange regulation)
More information is available=> disclosure information
Greater divisibility
Why does share analysts specialise within particular industries? (Practicality)
> Most companies within an industry are affected by similar factors
Information about these companies come from a common source and are presented in a similar way.
No-one can be an expert in all areas
Adds structure to the decision-making process. Assists in portfolio classification and management
Why are share price movements of companies in the same industry more correlated with each other than companies of other industries? (Correlation of investment performance)
- Resources=> similar resources=> similar input costs
- Markets=> Supply the same market=> similarly affected by the changes in demand
- Structure=> Similar financial structure=> similarly affected by changes in interest rates
