Chapter 10: Equity and property markets Flashcards
Define the term ordinary share and describe the features of ordinary shares
Ordinary shares are securities held by the owners of an organization
Features
● Shareholders have a right to receive all distributable profits after debtholders and preference shareholders.
● Dividends are related to profits and hence unknown in advance
● Dividends are variable but expect to generally increase over time
● Companies try not to reduce dividends (dividend cover ratio or payout ratio can be volatile)
● They rank behind all creditors for repayment on winding up.
● Ordinary shares have no final redemption date.
● They carry voting rights.
Dividend payout-ratio and dividend cover rate
Dividend payout-ratio = dividends per share / earnings per share
Dividend cover-ratio = 1 / Dividend payout-ratio = earnings per share / dividends per share
Suggest reasons why a company might want to buy back some of its shares
- Excess cash that cannot be used profitably and is
returned to shareholders - Excess cash may only earn deposit rate of interest,
thus disposing the cash improves earning per share for remaining shares - May be more tax-efficient way of returning cash to shareholders than dividends
- Company may wish to change capital structure from
equity financing to debt financing
Investment and risk characteristics of ordinary shares
Security: Depends on the security of the company, and on whether it is listed
Yield:
● long-term yield expected to be positive in real terms (inflation hedge)
● higher required returns than government bonds over the long term
● lower running yield than government bonds as much of the return is expected to be made from future dividend growth - Running (Dividend) yield = dividend per share / price paid per share
Spread/Capital volatility: income (dividends) and capital values (prices) can be volatile
Term: equities can generally be held in perpetuity
Exchange rate (Currency RIsk): Varied Expenses: dealing expenses are linked to marketability
Marketability: marketability depends on the size of the company and whether listed
Tax: income and capital gains taxed differently by different investors
Features of Preference Shares
● The dividend on a preference share is usually a fixed percentage of the par
value
…and is always paid before any distribution to ordinary shareholders.
● The dividends do not have to be paid if profits are insufficient.
● They are generally cumulative so that if a dividend is unpaid, the arrears must also be paid off before any payment is made to ordinary shareholders.
● They usually rank before ordinary shares for repayment on winding up.
● Most preference shares have no final redemption date.
● They do not normally carry voting rights.
Describe the cashflows on an ordinary share from the perspective of the investor
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
What are the advantages of listed shares over unlisted shares to the investor
- Greater marketability
- Greater divisibility
- More information is available, due to disclosure requirements
- Greater security, from stock exchange regulations
- Easier to value
Why is it necessary to categorise equities by industry?
Practical reasons:
- Most companies within an industry are affected by similar factors (and therefore have a correlation of their investment performances)
- The information about these companies tends to come from a common source and is presented in a similar way
- No-one can be an expert in all areas, so specialisation is appropriate
- It adds structure to the decision-making process
Reasons for the correlation of investment performance within the same industry
- Resources
- Companies in the same sector will use similar resources and will therefore have similar input costs - Markets
- Companies in the same sector supply the same markets, and will therefore be similarly affected by changes in demand - Structure
- Companies in the same sector often have similar financial structures and will therefore be similarly affected by changes in interest rates
Problems with industry groupings of equities
- Some companies operate throughout several sectors ie conglomerate companies
- The heterogeneity of companies within particular sectors - differences due to size or because they operate within different niches of the market
Freeholder vs Leaseholder
“Freeholder”
• Has outright ownership of a property (land + building) in perpetuity.
• Can (re) develop land, occupy it, rent it out.
• May be subject to various restrictions: covenants, easements (eg rights of way), planning and building
regulations, statutory requirements (eg not to cause a nuisance to others).
• If leases the property, freehold owner has use of property only at end of the lease
“Leaseholder”
• Has use of the property until end of the lease.
• Lease will impose various restrictions and requirements: use of property, maintenance, insurance, property
changes, sub-leasing
Investment and risk characteristics of domestic property
Security: Depends on the quality of the tenant(s), site value, political risk
Yield:
long-term return expected to be positive in real terms (inflation hedge)
● required long term return between government bonds and equities
● running yield varies, usually between government bonds and equities - running yield - rental income (net of management expenses) / cost of purchase (gross of all purchase costs)
Spread/Capital volatility: Step income (rent); capital values (prices) can be volatile but less than shares
Term: Freehold can be held in perpetuity
Expenses: dealing expenses higher than other asset classes; management costs high
Marketability: Very unmarketable as can take months/years to sell a large property
Tax: income and capital gains taxed differently by different investors
+ investment characteristics can be changed by the owner
+ property could be used by investor (i.e. utility value)
Types of Property
- Offices
- Shops
- Industrial property
- Shopping centres
- Retail warehouses
- Agricultural land and forestry
- Residential property
PROBLEMS with direct property investment:
Size usually too large for most investors
Diversification within property is difficult due to large unit size
Lack of marketability (time taken, costs)
Valuation is unknown and/or costly (surveyor needed)
Specialised expertise (property, local conditions) needed to invest and manage direct property
Types of indirect property investment
Pooled property funds
- include open-ended unitised funds (unlisted: price = NAV) and closed-ended property investment trusts (listed: price < NAV normally)
- normally have constitutions that specify the type of property that can be invested in
- these are trust REIT’s (Real estate investment trusts)
Property shares
- companies that manage, operate, and own a real estate portfolio consisting of income-producing property)
- these are company REIT’s
NB table slide 41
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