Chapter 10: Equity and property markets Flashcards
What are ordinatry shares?
Ordinary shares are securities held by the owners of an organisation.
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 righ to attend and vote at general meetings of the company.
List 11 investment and risk characteristics of ordinary shares
- Income = dividends = share in company’s profits
- Capital gain may arise on sale of share
- Default risk depends on security of issuing company
- Security of capital depends on NAV, level of gearing and the risk profile of the issuing company.
- Higher long-term expected return than government bonds
- Expected to provide a real return over the long term
- Potential for volatile markets (and dividends)
- Term: no fixed redemption date, generally considered to be long-term
- Dealing costs higher than for conventional government bonds
- Marketability depends on the issuing company and whether it is listed or not - generally worse than for government bonds
- Tax treatment depends on territory.
Describe the cashflows on an ordinary share from the perspective of the investor
Share purchase:
- An initial lump sum negative cashflow 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 are 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 subsidise dividends in poorer years.
Final payment:
- There is no redemption payment - dividends can be assumed to continue indefinitely
* However, there will bre a final positive cashflow, which is unknown in timing and amount 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
Investment analysts specialise within particular investment sectors because?
- The factors affecting one company within an industry are likely to be relevant to other companies in the same industry.
- Much of the information for companies in the same industry will come from a common source and will be presented in a similar way.
- No single analyst can expect to be an expert in all areas, so specialisation is appropriate
- The grouping of equities according to a common factor gives structure to the decision-making process. It assists in portfolio classification and management
List the 3 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 to 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.
What are the practical difficulties with industry groupings?
- Companies that operate throughout several sectors - i.e. conglomerate companies.
- The heterogeneity of companies within particular sectors.
Why are market movements the biggest influence on a share’s price?
- Most companies are affected by macro-economic factors and the political climate in similar ways
- Most companies’ costs are affected by similar factors, e.g. tax, labor markets, cost of borrowing and fuel.
- Many investors are interested in equities as a whole rather than in specific shares, because:
* The equity market appears attractive compared to another market
* Investors have real liabilities
* Regulation and tax breaks tend to favor equities - Many investors invest passively in instruments covering a broad range of equities rather than actively seeking out specific shares, because:
* They believe the costs of active management are not compensated for by sufficient extra return
* They lack the expertise.
What are quoted shares?
Quoted shares are listed on a stock exchange and make up the majority of available equity investment
What are the investment characteristics of quoted shares?
- more marketable
- more secure
- easier to value than non-quoted shares
What are preference shares?
A particular class of share that generally ranks ahead of ordinary shares.
Normally entitled to a specific rate of dividend, and, unlike ordinary shareholders, not to residual profits.
Typical features of preference shares
- Dividend on a preference share is usually fixed percentage of the par value and is always paid before any distribution of ordinary shareholders
- Dividend on preference shares is normally treated in the same way as ordinary shares for tax purposes
- Dividend rate is quoted net of tax
- Dividends don’t have to be paid if profits are insufficient
- Generally cumulative
- Mostly no final redemption date
- Normally don’t carry voting rights
Reasons for buying back shares
- 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-efficietn than dividends
- Company may wish to change capital strucutre from equity financing to debt financing
List 14 investment and risk characteristics of direct property
- Risk of voids and tenant default
- Risk of political interference
- Risk of obsolescence and need for refurbishment
- Real return, broad hedge for inflation
- HIgher expected return than for government bonds
- Income forms a ‘stepped’ pattern over time
- Running (rental) yields varies by the type of property
- Volatile capital values in long term, stable capital values in short term.
- Subjective, infrequent valuations, lack of information
- High dealing costs and management costs
- Very unmarketable
- Large unit size, indivisibility
- Uniqueness
- Characteristics can be changed by owner, e.g. redevelopment
On what factors would prime property score highly?
- location
- age and condition
- quality of tenant
- the number of comparable properties available to determine the rent at rent review and for valuation purposes
- lease structure
- size
What is obsolescence?
Obsolescence arises when a building becomes out of date and is no longer of use to potential tenants.
It means that even if average property values rise in line with inflation, the value of a particular building may fall in real terms.
List 3 examples of indirect property investment
- Pooled property funds
- Property company shares
- Listed JSE Real Estate Investment Trusts (REITs)
What are the disadvantages of direct property investment that can mostly be avoided by investing in indirect property?
- Size
- Diversification
- Lack of marketability
- Valuation
- Expertise needed
What are JSE REITs?
JSE REITs are companies that manage, operate and own a real estate portfolio consisting of income-producing property.
These can be divided into:
1. Trust REITs, and
2. Company REITs
These REITs operate in a strong legislative environment since they are subject to Listing Authority rules, REIT legislation and their own Articles of Association or Unit Trust Regulation.
Define net asset value per share
Net asset value per share is the value of the company’s assets divided by the number of shares.
Net assets in this definition mean assets net of liabilities.
We also net off intangible assets.
This is because net asset value per share represents a company’s wind-up value per share.
Upon wind up, intangible assets such as goodwill are unlikely to have a significant value.
What does the discount to NAV reflect?
- any difference between the way in which investors value shares and the way they value property
- risk of loss on forced sale - cashflow requirements result in property companies being more likely to be forced sellers of properties than institutions undertaking direct property investment on their own account.
A smaller discount, or possibly even a premium, to NAV is possible where:
- the marekt has a positive view of developments giving the potential for capital gains
- the valuations underlying the NAV are conservative
- the property company has a good management track record
