Investments Topic 4 - Equities Flashcards
What is the definiton of equity
Equities means the gap between the value of an asset and any liabilities attached to it
By law, a company must have ordinary shares
The amount and type of shares must be written down in 2 documents
- Memorandum of association – legal statement signed by all initial shareholders or guarantors agreeing to form the company
- Articles of association – written rules about running the company agreed by the shareholders or guarantors, directors and the company secretary
Any companies listed on recognised UK stock markets are…companies
Limited liability
How often can dividends be paid and what are the technical names for these timeframes
Interim – dividends paid every half-a-year
Final – dividends paid at end of trading year
Important terms in relation to dividends:
* Record date
* Payment date
* ex-dividend date
* cum dividend
- Record date – Cut-off date where if an investor buys shares after that date they will not be entitled to the next set of dividends
- Payment date – date where dividends are paid out
- Ex-dividend date – usually 2 days before the record date, if holders or buyers have shares before this date, they qualify to receive the dividend that has been declared
- Cum dividend – if you buy before the ex-dividend date
2 circumstances where a company will issue shares
- When the business first registers as a public company – known as initial public offering (IPO)
- When they need capital – sometimes known as secondary public offering
Company’s IPO must be arranged in 2 ways
offer of sale or a placing
Offer for sale – offered in 3 ways:
Names and descriptions
- Fixed price – shares sold at a fixed price, just below predicted market value. Offer is underwritten, which means large banks and companies agree to buy any remaining shares – this is good but costs the company millions, so dilutes the cash flow.
- Tender – used for smaller companies in which investors have uncertainty. Bids are made for the shares, then once they all come in, advisers decipher a ‘strike price’ which is a fair price based on all the bids and the predicted market price. Anyone who bid on or over the strike price will then most likely receive shares for the strike price. Sometimes, if they bid over the strike price they will pay the amount they bid for their shares.
- Subscription – a form of tender where bids must be at the minimum price (subscription price) and the number of bids must meet a predetermined number of shares. If there are not enough bids, the shares are not issued.
What is Placing
Company offers its shares to bigger institutions through stockbrokers or advisers. This is most common for smaller companies due to the big charge on marketing and administrating shares to the public.
Building societies could change to being a public company by either:
- IPO
- Converting reserves they have into share capital (creatin shares from their own reserves and giving them out for free to existing members).
What is a rights issue
A rights issue is when the company will offer existing holders the opportunity to buy new shares in proportion to the number of shares they already hold. Or, they can take a cash amount that is equal to the share price
‘Tail swallowing’ is a term used when
sells enough nil-paid rights for them to make most of their rights and buy more new shares without investing any money
What is a scrip issue
where a company will redistribute some of its reserve money into newly formed shares. These shares will not change the value of the holder’s holdings but will give them 1 new share in a 1-for-1 scenario. This is done so that the company can gain funds from its reserves and put it into its share capital.
What are share splits
when a company will change the par value of shares to make the shares cheaper to buy for secondary market investors. If they divide the par value by 4, existing shareholders will have 4x the amount of shares they had before, this making each individual share worth ¼ of the price.
Ordinary shares:
- Most common type, carry voting rights
- Dividends available
- If company is wound up, they will be the last to be paid back
- Must have them by law
Preference shares:
- Similar to loan stock but they pay dividends every 6 months
- Rank ahead of ordinary shares to repayment
- They pay a fixed dividend payment providing there is enough money to pay it
- Dividend is usually lower than that of an ordinary share due to it being less risky
- Do not carry voting rights
- Fixed dividends are good for if profits are low, bad if profits are high
Cumulative preference shares
This is when current year’s dividends plus unpaid previous year’s dividends are paid, this takes priority over ordinary shares payment too.
Participating preference shares
This is when you receive your fixed dividend but may also receive additional dividend which is a limited share of the company’s profits. Usually worked out as a percentage of the ordinary share’s dividends
Convertible preference shares
Usually pay lower dividends but have the chance to convert to ordinary shares for a fixed price at a fixed date. This type of share usually costs more to buy, and if you miss the date, you have no option to change
Warrants
issued by companies (usually investment trust companies) and give them the right to subscribe for a given number of ordinary shares. No dividends received as they hold no shares.
what 2 markets are there to be traded on (equities)
the main market (LSE) and the alternative instrument market (AIM)
Main market (LSE) key points (for companies that are listed on here)
- Will be on the stock exchange if the company meets very strict rules
- Large amount of financial information must be accurately disclosed
- Must have been trading for at least 3 years, and 25% of shares held by public
- ‘free float’ or ‘public float’ refers to shares that are readily able to be sold, and not held by shareholders who cannot/do not want to sell their shares
alternative instrument market (AIM) key points
- Mainly intended for smaller companies – additional, separate market on the LSE
- Enables these smaller companies to have a bigger audience and offers a platform for shares to be bought and sold
- Rules for joining are much less strict
- Investors should be much more knowledgeable to trade in this market
Shares can be bought through a
stockbroker
Unlisted securities refer to shares in companies that are not
listed on stock exchange due to not being big enough or wanting to stay private.
Investors in unlisted securities can benefit from a number of tax advantages, such as:
- Capital losses – if shares are bought (not transferred) and make a loss, they can be offset against other income. The issuing companies must qualify for the EIS to be able to receive this relief
- Interest relief – this is relief on the interest of loans used to buy shares in a close company, can claim tax relief at their highest rate. Investor must own 5% of shares or work for majority of their time in management. Relief not available if EIS income tax relief has already been paid.
- IHT business property relief available on 100% of shareholdings in unlisted or AIM-listed companies if shares have been held for at least 2 years
4 key measures when assessing the value of a share
- Dividend yield
- Price-earnings ratio
- Net asset value
- Dividend cover
Dividend yield
- Measure of income received in relation to the current share price
- Yield will fluctuate up and down
Dividend cover
- Dividends paid out of profit, usually expressed as earnings per share (EPS)
- Some profits kept in the business; dividend cover is the amount of times that the dividends COULD be paid from their profit
- It is calculated by dividing the EPS by the net (paid out) dividend
- The higher the number, the higher confidence holders have that they will be paid
Price/earnings ratio
- P/E is the share price divided by the earnings per share
- P/E shows how expensive a share is to buy compared to how much you will earn from it
- The higher the P/E, the more confidence the market has in the company
Net asset value:
The NAV is the market value of all of a company’s assets, less liabilities, divided by the number of shares issued. This gives you the notional value of each share if the company was to be wound up.
Gearing
Gearing - the extent of the company’s long-term borrowing, calculated by dividing the long-term debt by shareholder capital and reserves.
If the company has a higher gearing percentage, then it is using borrowing to fund the majority of its spending, which can be a red flag to investors.
Factors affecting share prices:
- S&D
- Performance of the company
- External factors – Interest rates, economy, government policies etc.
- Market sentiment – the market as a whole sometimes tends to shuffle going up or down in response to worldwide issues etc
Costs involved in shares
- The spread – difference between buying price and selling price (profit)
- Commission
- Stamp duty – payable whenever shares are bought
- Panel of takeovers and mergers levy – charged on sales over a certain threshold
Save-as-you-earn-linked (SAYE-linked) share option schemes
- Offers employees and directors the opportunity to save over a fixed period
- At the end of the period, they can use the savings to buy shares in the company at a good price
- Can save between £5-£500 per month
- Contributions deducted from pay but don’t have tax relief
- Contract for 3-5 years
- Price of shares must not be less than 80% of market value
- No income tax arises when shares are exercised
- Employee can take saved cash or buy shares
- Can transfer shares into ISA or stakeholder pension scheme within 90 days
Free shares
Share incentive plans
- Employer defines criteria on which free shares are awarded – e.g. salary, length of service or performance target
- Evidence must be supported for performance-based reward
- Max. amount annually granted is £3,600
- Shares must be held for the minimum of 3 years up to 5 years, otherwise income tax is payable on the lower market value of the shares on the exit date
Partnership shares
Share incentive plans
- Employees can sacrifice up to 10% of their salary – max. of £1,800 annually
- In return, they get partnership shares
- No income tax or NICs paid on salary sacrificed
- Shares can be withdrawn at any time, but charges apply if you take them out before 3 or 5 years
Matching shares
Share incentive plans
- Employer can offer to pay matching shares for employees who buy partnership shares and are held in trust for the employees
- Must be held for 3 to 5 years
- Taxation of these is the same as free shares
CGT on these schemes is only payable if you withdraw the shares…
before they are sold
