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Section 3 - Equities and Property Flashcards

1
Q

How are shares offered to the public?

A
  • To offer shares to the general public usually need to be listed on stock exchange
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2
Q

Why would an investor invest in Equities?

A
  • Investors hope to receive income from dividends & capital growth
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3
Q

What are share prices affected by?

A
  • Economic & political factors: inflation, productivity, growth & government policy fiscal & monetary
  • Investor sentiment
  • Factors specific to business: profit/dividend expectations, take-over activity and management track record
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4
Q

Where are securities (Shares) issued for the first time?

A

Primary Market

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5
Q

Where are securities (Shares) issued when they have already been issued previously?

A

Secondary Market

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6
Q

Name the main equity markets

A

London Stock Exchange and ICAP Securities & Derivatives Exchange (ISDX)

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7
Q

What are the Three main types of IPO

A

o Offers for sale (at a fixed price or tender price)
o Placings (with big institutions)
o Introductions (introduced to the exchange)

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8
Q

What is an initial public offering

A
  • When a company obtains a stock market listing
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9
Q

what are the alternative investment markets?

A
  • Provides primary & secondary market functions to companies too small/new to have full stock market listing
  • Properly regulated but less onerous listing requirements
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10
Q

how can you purchase or sell shares?

A
  • Trade through stockbrokers either directly or via bank/building society
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11
Q

Name the main costs of purchasing and selling shares

A

o Commission charged on purchases and sales
o Stamp duty/stamp duty reserve tax (SDRT) - on transfer of UK shares
o 0.5% paid by purchaser
o Stamp duty rounded up to the next multiple of £5
o SDRT rounded to the nearest penny
o No SDRT and stamp duty on shares in companies quoted on AIM
o Panel on Takeovers & Mergers levy - flat charge of £1 on all trades over £10,000

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12
Q

What are interest bearing securities

A

interest-bearing securities are a class of financial instrument whereby as an investor, you effectively lend money to a company or institution that pays you interest in a prescribed way over a prescribed period of time

In interest-bearing securities, funds are raised by issuing (selling) a financial instrument to a buyer (lender) that represents a promise by the issuer (borrower) to make interest-only payments throughout the term of the security (typically six-monthly) and repay a specified principal amount at the end of its term (at ‘maturity’). In the case of loans (such as mortgages, car loans), the principal amount is generally borrowed up-front at the start of the loan, and principal-and-interest is repaid progressively, usually monthly or fortnightly, throughout the term of the loan

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13
Q

what are the key points of a preference share?

A
  • Usually fixed rate of dividend paid half yearly
  • Dividends paid before dividends on ordinary shares but only if sufficient after-tax profits
  • Lower security than bonds but higher yields
  • Usually undated
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14
Q

What are cumulative preference shares?

A

Preference shares Will be cumulative unless specified
Any dividend shortfall carried forward must be paid before dividend declared to ordinary shareholders

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15
Q

Briefly explain non - cumulative preference shares?

A

Lose right to unpaid dividends at end of financial year

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16
Q

Briefly explain participating preference shares?

A

Pays fixed rate of dividend and allowed to participate in profits of company

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17
Q

Briefly explain redeemable preference shares?

A

Redeemable at a specified pre- determined date

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18
Q

Briefly explain convertible preference shares?

A

Can be converted into ordinary shares

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19
Q

what are the main types of ordinary shares?

A

o A shares (non-voting)
o B shares
o Deferred shares (don’t usually qualify for a dividend until dividends on ordinary shares reach
a pre-determined level)

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20
Q

What rights do owners of ordinary shareholders have

A
  • Entitled to all of profit after tax and preference shares
  • Although some profits will be retained in business to increase value
  • Entitled to vote
  • Entitled to residual value of company assets after debts
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21
Q

How are dividends paid to ordinary shareholders and what are the allowances and tax brackets

A
  • Paid out of profits
  • Board of directors determine amount
  • No tax on first £1,000 of dividends received
  • Then: basic rate taxpayers pay 8.75%, higher rate taxpayers pay 33.75% and additional rate taxpayers pay 39.35%
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22
Q

what are rights issues used for?

A
  • To fund expansion plans
  • Strengthen balance sheet
  • Refinance the company after a crisis
  • Offered first to existing shareholders
  • Expressed as ‘1 for 3’ or ‘2 for 5’ etc
  • Price for new shares below current market price
  • Rights issues lead to changes in share price
  • Price original shares fall to - theoretical ex-rights price
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23
Q

what are the Options Under a Rights Issue?

A
  • Subscribe for new shares and pay full amount
  • Sell rights in the market
  • Sell enough to generate cash to take up remainder
  • Lapse - company sells and distributes proceeds after costs
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24
Q

what are bonus shares?

A

*A scrip issue, or bonus issue, is when a company creates new shares and awards them to existing stockholders.
*Used to bring share capital more in line with real worth
* Reduces the share price to make it more attractive
* Shares are issued fully paid to shareholders
* Also called scrip issue

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25
Q

What are share splits?

A
  • Also to achieve lower share price
  • Increases number of shares in issue by splitting par value
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26
Q

What are indices?

A
  • Index provides means of measuring performance of portfolio of shares over time
  • Indices used to:
    o compare particular share to overall market
    o compare fund manager’s performance to overall market performance
  • Variety of indices constructed in different ways - reflect different markets
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27
Q

Describe market capitalisation?

A
  • Stock market valuation of company
  • Multiply number of shares in issue by share price
  • The bigger the company the bigger the weighting in the index
  • Free float is the proportion of shares available to trade on stock markets
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28
Q

What does the fTSE all-share comprise of?

A
  • FTSE 100
  • FTSE 250
  • FTSE Small cap
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29
Q

What does the fTSE 100 comprise of?

A
  • 100 largest companies by capitalisation
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30
Q

What does the fTSE 250 comprise of?

A
  • Next 250 companies by capitalisation (below the FTSE100)
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31
Q

What does the fTSE 350 comprise of?

A
  • FTSE 100
  • FTSE 250
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32
Q

What does the fTSE small cap comprise of?

A
  • Comprises remaining companies in FTSE All Share that don’t qualify for FTSE 350
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33
Q

What does the fTSE fledging comprise of?

A
  • Companies too small to qualify for the FTSE All-Share
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34
Q

name 3 other FTSE indices?

A
  • TMT - technology, media and telecommunications
  • techMARK All-Share - all companies in techMARK sector
  • FTSE4Good - companies meeting globally recognised socially responsible standards
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35
Q

name 2 specialist indices?

A
  • FTSE Actuaries UK Conventional Gilts All Stocks Index
  • FTSE Sterling Corporate Bond Index
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36
Q

Name 3 US indices

A
  • Dow Jones Industrial Average: 30 blue chip companies
  • Standard & Poor’s (S&P) Composite: 500 companies
  • NASDAQ composite: small, young companies
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37
Q

Name 2 Japanese indices

A
  • Nikkei 225: average of 225 stocks
  • Tokyo Stock Exchange Index (Topix)
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38
Q

what is the main indices in Germany

A
  • DAX 30:30
    largest companies
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39
Q

What is the main index in Hong Kong

A
  • Hang Seng: representative sample
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40
Q

What is the main index in France

A
  • CAC General Index: CAC 40
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41
Q

What are the limitations of Indices?

A
  • Weighted by market capitalisation - a few companies can have substantial effects
  • Costs - no account of tax, buying/selling costs or management expenses
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42
Q

key facts of investing in property within a portfolio?

A
  • Offers different characteristics from other assets
  • Prices affected by supply & demand
  • Commercial property cycle different from residential property cycle
  • Wide range of property types
  • Consider direct investment or through collective
  • Asset backed investment so can provide long-term inflation protection
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43
Q

Disadvantages of investing in property

A
  • Lack of liquidity
  • Costs
  • Whether to self-manage or use an agent
  • Void periods - loss of rent (no tenant or tenant failing to pay rent)
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44
Q

points to consider when investing in property?

A
  • Location - usually most important issue
  • Tenant availability
  • Tenant quality
  • Age & condition - newer property preferable for renting
  • Diversification - if properties in same area then risks are concentrated
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45
Q

how does investment in property have prospect for capital growth

A
  • Long-term prices tend to follow growth in average earnings
  • Expected yield - generally the larger the property the lower the yield
  • General expenses on average reduce yield by 25%
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46
Q

what is Stamp duty land tax

A
  • In England and Northern Ireland
  • SDLT is paid at the rate of tax on the part of the purchase price within a tax band
  • HMRC must receive the tax within 30 days of the transaction date (changing to 14 days from 1 March 2019)
  • There is a 3% surcharge on top of normal SDLT rates when buying a second property
    o With effect from 22 November 2017, exemptions to this surcharge are available to those increasing their share in their own home, families affected by a court order for divorce, a spouse buying a property from their spouse and cases where a property is held in trust for children who are subject to a Court of Protection order.
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47
Q

Advantages of investing in property

A
  • Diversification
  • Gearing
  • Income stream (rent)
48
Q

Disadvantages of investing in property

A
  • Interest rate risk: mortgage cost increases
  • Capital / market risk: capital values fall
  • Liquidity risk: unable to sell at a specific price at a specific time
  • Income / tenant risk: falling rent / void periods / tenant default
49
Q

name 4 indirect property investments

A
  • Special purpose vehicles
  • Listed property companies
  • Insurance Company property funds (Life funds)
  • Property unit trusts
50
Q

what are the qualifying features of a furnished holiday let

A
  • Must be in the EEA
  • Furnished
  • Let on a commercial basis for at least 210 days per tax year
  • Must be actually let out for 105 days per tax year (can be averaged over more than one property)
  • Can be continuously let out for more than 31 days but no more than 155 days per tax year
51
Q

Andy is a higher-rate taxpayer who is selling a buy-to-let property for £220,000 that he bought 15 years ago for £153,000.
There is an outstanding interest-only mortgage on the property of £110,000. Andy has no other capital gains or losses for the tax year 2021/22.
What amount will Andy receive after Capital Gains Tax (CGT) and redemption of the interest- only mortgage?

A
  • 1: 220,000
  • 2: 220,000 – 153,000 = 67,000
  • 3: 67,000 – 0 = 67,000
  • 4: 67,000 – 0 = 67,000
  • 5: 67,000 – 12,300 = 54,700
  • 6: 54,700 x 28% = 15,316 CGT payable

The interest-only mortgage must be redeemed from the sale proceeds: 220,000 – 110,000 = 110,000
Less the CGT payable,

110,000 – 15,316 = £94,684 received after CGT and redemption of the interest-only mortgage

52
Q

what are the costs involved in selling a property

A
  • Legal (ie. solicitor) / conveyancing fees
  • Estate agent fees
  • Any mortgage redemption fees / lender’s administration fees
53
Q

Property Yield Calculation

A

This is just the HPR, but unlike equity and bond investments, you will need to factor in the ongoing property management costs and the cost of purchasing the property:

54
Q

what is rent a room relief

A
  • ‘Rent a room relief’: letting furnished rooms in main residence
    o Individual must also occupy property at the same time
    o No tax if gross rent is below £7,500
    o One exemption per residence
55
Q

state the property income allowance?

A
  • £1,000 for individuals
  • If this covers rental income it does not need to be declared/no tax due
  • Income over £1,000 can deduct the allowance from gross income or
  • Deduct actual expenses (in which case allowance will not apply)
  • Doesn’t also apply where rent a room relief applies
56
Q

How many companies are listed on the London stock exchange?

A

2000+

57
Q

what are preference shares?

A

Preference shares do not normally carry the right to vote, but unlike ordinary shares preference shares carry an expectation of a dividend. This is payable after interest payments (bondholders), but before ordinary dividend payments.

It is named a preference share because the preference share takes preference over ordinary shares; all shareholder rights are written in the company’s Articles of Association.

58
Q

what are Cumulative preference shares

A

A cumulative dividend means that, where the company does not pay a dividend the right to receive that dividend is rolled into the next period. Ordinary dividends cannot be paid until ALL of the cumulative preference dividends have been satisfied.

59
Q

what are Participating preference shares

A

Most preference shares are only entitled to a fixed rate dividend, but where additional dividends could be paid, over and above the fixed rate then participating preference dividends (extra dividend) could be paid.

60
Q

what are Convertible preference shares

A

A preference share with rights to convert into an ordinary share.

61
Q

what are Redeemable preference shares

A

When preference shares are issued as redeemable, they carry a specified redemption date when the company will refund the nominal (par/face) value.

62
Q

what are Zero dividend preference shares

A

Affectionately named “zeros”, zero dividend preference shares have a fixed maturity date and also provide a fixed return. They get paid out before ordinary shares and are often regarded as being lower risk. Zeros have no voting rights and are subject to Capital Gains Tax (CGT).
It is important to know the following four terms with regard to zero dividend preference shares:

Capital Cover:

  • Measures the assets ability
  • To meet the redemption price of the zeros

Thus, a Capital Cover greater than 1 means that the zeros are fully covered by assets.

63
Q

(Zero) what is the Hurdle Rate (to Redemption):

A
  • Is the annual growth rate required in the assets
  • To cover the zeros

Thus, a Hurdle Rate of 9% means that the assets need to grow by 9% and the zero would still be repaid.

64
Q

(Zero) Hurdle Rate (to Wipeout):

A

At what point will zero dividend preference shareholders receive NOTHING?

Thus, a Hurdle Rate (to Wipeout) of 90% means that the assets would have to fall by 90% before zero holders received nothing.

65
Q

(Zero) Negative Hurdle Rate:

A

This is the amount that the assets can fall each year and still be sufficient to repay the zeros in full.

66
Q

what are American Depositary Receipts ADR and why do we use them?

A

These are used by British companies to encourage US investors to buy an equity stake in a UK company.

Why do we have them?
US investors like dollar shares and to receive dollar dividend income. Therefore, an ADR represents a shareholding in a British (or other non-UK company), although it is shown in dollars.

67
Q

what are the Statutory rights for shareholders in the UK

A

o companies must hold AGMs at least once per year
o shareholders with more than 10% of voting rights can call EGMs
o shareholders with more than 5% of voting rights can propose resolutions
o any shareholder can petition the court on grounds of the affairs of the company that are unfairly prejudicial to the interests of some or all of shareholders.

68
Q

what are some investment considerations for property investment

A
  • Quality of tenant and their on-going ability to pay the rent
  • Commercial property owners prefer long leases as they enhance property values
69
Q

what are some problems of Commercial Property Investment

A
  • Slow sale and purchase
  • Property not easily divided into segments
  • Market difficult to analyse
70
Q

How does the calculation of stamp duty and stamp duty reserve tax differ in their rounding?

A
  • Stamp duty rounded up to the next multiple of £5
  • SDRT rounded to the nearest penny
71
Q

What is the main characteristic of a non-cumulative preference share?

A
  • They lose the right to receive any unpaid dividend at the end of financial year and no arrears are due when dividend payments resume
72
Q

What are the three main reasons a company will make a rights issue?

A
  • To fund expansion plans
  • To strengthen the balance sheet
  • To re-finance the company after a crisis
73
Q

What rate of tax will a basic rate taxpayer pay on a dividend payment over the dividend allowance?

A
  • Basic rate taxpayers will pay 8.75%
74
Q

What is the tax-free limit for ‘rent a room relief’?

A
  • No tax is paid if gross rent for a tax year before expenses is not more than £7,500
75
Q

what are the Principal features of AIM

A
  • Launched in June 1995
  • Currently lists circa 1,000 companies with a total market capitalisation of £93bn
  • Many AIM companies lack true liquidity (sometimes ANY liquidity!)
  • Lower listing standards and “lighter touch” regulation than for the main LSE market – which has been a major criticism of the AIM
  • Lower listing fees and ongoing costs than for the main LSE market
76
Q

what is the alternative investment market

A

This is a trading marketplace for (often young) smaller UK companies. By definition, it is much higher risk than buying shares in companies listed on the Main Primary London Stock Exchange (LSE).

77
Q

what are the advantages are investing in the primary market

A

When a company is listed on the primary market this is known as an Initial Public Offer, or IPO.
* From an investment perspective the advantages of investing in an IPO rather than in a company already trading on the secondary market are:
* The shares may be priced at an attractive level to ensure good take-up,
* Transaction costs will generally be lower / no dealing commissions, and
* There may be a limited supply of shares. Financial institutions such as pensions funds may require exposure to a specific newly-listed company and this demand may force the price higher than the initial offer price

78
Q

what are the disadvantages are investing in the primary market

A

the disadvantages of investing in an IPO rather than in a company already trading on the secondary market are:

  • No track record for the company’s commercial (business) / investment (share price) performance: a lack of hard factual trading data to analyse,
  • Companies generally list via IPO at times which are “favourable” to the company’s existing management / founders: not “favourable” to investors! A substantial amount of financial accounting “window dressing” may well take place!
  • There may be less stringent reporting requirements at the time of the IPO,
  • Share allocations may be scaled-back if the issue is over-subscribed: ie. investors in the IPO may get less shares than they applied for,
  • At initial listing the share price may be subject to high volatility.
79
Q

what is a offer for sale

A

An offer for sale involves the company issuing the new shares selling the issue to a company called an issuing house, typically merchant banks, investment banks, and brokers offer this service. The issuing house initially buys up new shares from the issuing company before re-selling them. This can also be used for a large shareholdings including government sell-off or privatisations.
- The issuing house will buy the shares from the company at a lower price than it intends to sell them, so they can make a profit.
- The company directors will prepare a detailed prospectus called an offer document, which needs to be assessed by an independent specialist consultant.
- An advert called a “formal notice” will be placed in the newspaper

80
Q

It can sometimes be difficult to price initial offers of shares or find the right market for ‘placing’ them. With this in mind, what are the main options:

A
  1. Fixed price: a fixed price is stated and offered on that basis (sometimes this initial price is set low to encourage take up). Getting the balance right is tough. The fixed price is typically set at the price just below where they could realistically expect full take-up, and to encourage an active secondary market. Sometimes, shares can be oversubscribed as the shares are being marketed too cheaply. The offer document will contain instructions on how to handle this. Due to these issues, and the difficulty in setting a fixed price, companies often prefer to use a tender basis.
  2. Tender: investors make bids for amounts of stock and the price they’re willing to pay. Based on the bids, a strike price is set, with anyone who bid above the strike price paying the strike price for the stock. The advantage here is that the market has had an input in the pricing of the share, and the potential for oversubscription is limited.
81
Q

What is a offer for subscription?

A

An offer for subscription involves a company issuing shares directly to the general public and offering them for sale direct (subscription). This typically involves an issuing house underwriting the offer, meaning they’ll agree to purchase any unsold shares for a fee. This method is rarely used these days and then typically only be new investment trusts. An offer for subscription can either be on a fixed or tender price basis.

82
Q

what is Placement/selective marketing

A

The shares are marketed directly to preferred, specially selected institutional investors, hence the term “selective marketing”. These investors include pension funds, investment banks, and life funds. The advantage is that the prospectus doesn’t have to be quite as detailed, and companies may find this the cheapest way to sell their issue. It’s a popular option.

83
Q

In terms of pricing shares, what are introductions?

A

This involves a company already listed on one exchange the ability to “seek an introduction” to sell shares on another exchange. No new shares are issued – this gives foreign companies new markets to sell their shares, and domestic investors access to the shares of foreign companies they may not otherwise have access to.

84
Q

how are share prices valued

A

Shares have a nominal/face/par value shown on the face of the share certificate. This is the par value and is virtually irrelevant in normal trading conditions.
The market value is the trading price of the share on the market. This is the capital value of that share in the market and used to provide the total ‘capitalised’ value of the company: shares issued x market value = capitalisation.

85
Q

A company offers a 1 for 2 bonus issue, with the current share price £8; calculate the theoretical ex-bonus price.

A

Before: 2 shares x £8 = 16

After: 3 shares = 16

Share price after the bonus (ex-bonus price) = 16/3 = £5.33 This company has the same capitalisation in each case:
2 x 8 = £16

3 x 5.33 = £16

86
Q

What are share splits

A

A share split is where shares in issue are split into a greater number, each with a smaller nominal value: one £2 ordinary share is split into two £1 ordinary shares.
The effect is the same as a bonus issue: the total value of the company is spread over a larger number of shares (with a lower market price).

87
Q

What is the opposite of a share split?

A

The opposite of a share split is a share consolidation, where existing shares are consolidated into a smaller number, each with a higher nominal value (as RBS did in 2012 after the credit crisis when the share price dropped so low).

88
Q

What is a share buy back?

A

The purchase by a company of its own shares is called share buy-back. Regulatory as well as shareholder approval is required before a company is allowed to buy back its shares, but this can be done. In fact, business protection policies on director/shareholders for company share buy-back can be put in place – and this is where it is used most frequently.

89
Q

How does a share buy back increase the share price?

A

Buy-backs increase share price for a couple of reasons, broadly by reducing the number of shares in the market (scarcity) and mathematically when market capitalisation is considered. They’ve been recently criticised, with companies accused of increasing share prices via buy- backs rather than increasing profitability of the company.

90
Q

What are equity warrants?

A

Warrants give (the owner) the right (not an obligation) to purchase new shares at a fixed price in the future.
They are very similar to call options in the way they work but there are some key differences, for example, one major difference is the expiry date which is several months or years away and the other is that options are traded on an exchange, whereas warrants are issued by companies to raise money (although warrants are also traded).

A warrant is a security giving the holder the right to buy new shares; an option is the right to buy shares already issued and trading on the secondary market (stock exchange – the LSE). A warrant is for new shares which will be issued by the company.

91
Q

What is the difference between the seller of an option compared to a warrant

A

The seller of an option is responsible for delivering the shares; the seller of a warrant is selling a right to buy shares directly from the company (who are issuing the warrant contract).

92
Q

what are the two components that a warrant is made up of?

A

strike/exercise price and premium.

93
Q

If a warrant has an exercise (or strike) price of £5 and the market price is £6, the premium / profit will be

A

£1;
it is the amount gained (profit) by exercising the warrant now (if it could be). In this example, the warrant has intrinsic value.

94
Q

If a warrant has an exercise (or strike) price of £5 and the market price is £4, the premium or profit/loss will be

A

negative £1; it is the amount lost by exercising the warrant now and wouldn’t be exercised. It has no intrinsic value (although, it may have some ‘time’ value as it may be some time before the warrant option expires).

95
Q

Calculate How much you would pay for the below option

Cost of warrant £1.20
Exercise/strike price £5
Market price £6

Premium = ([strike price + cost of warrant] – market price)/market price

A

= ([6.20] – 6)/6 = 3.33% premium on the current market price of the share.

If you have to pay for the warrant, it has to be worthwhile, otherwise why do it?

96
Q

what are covered warrants

A

Warrants in a company’s shares issued by financial institutions such as investment banks and then made available for trading on the London Stock Exchange. They are referred to as ‘securitised derivatives’. These are derivatives – these are options contracts used for ‘trading’ equities, rather than being used by the actual company to genuinely raise cash.

Covered warrants are warrants in a company’s shares issued by someone other than the company, who also ‘cover’ their warrant issues by holding shares in the company – hence they are called ‘covered’ warrants. They cover their exposure by holding the asset.

Covered warrants typically have longer expiry periods and can be formed on call or put options (right to buy and sell shares), which means that whilst warrants are settled via the issue of shares covered warrants are traded for cash settlement. The maximum loss an investor can make is only the amount invested.

97
Q

what is a put covered warrant?

A

A ‘put’ covered warrant gives you the right to sell a share at an exercise price on expiry (and for which you pay a premium (warrant)).

98
Q

if you have a bearish view on BP over the next 3 months and buy a put covered warrant on the BP share for a premium of 47p with a strike price of 475p

what is the break even point

A

428p is the ‘’break-even’’ of the covered warrant; 428p = Strike price – 47p (price of warrant, which is negative here because we make money on falling prices with a put option).

99
Q

if you have a bearish view on BP over the next 3 months and buy a put covered warrant on the BP share for a premium of 47p with a strike price of 475p

how will you make a profit?

A

If the underlying level falls below 478p, you will make a profit at maturity by selling the shares at, say, 400p and making a profit of 75p on the strike/excercise price of 475; less the 47p = 28p profit per share (when the share drops to 400p).

Remember, you have a sell option at the strike price (the put option) and are expecting the BP price to fall – falling any further than 428p and you are ‘in the money’.

100
Q

what does EPS represent?

A

This is the profit that could have been paid as an ordinary dividend, calculated after all expenses have been deducted. This is a KEY ratio.

EPS is an absolute and specific figure where the trend in EPS over time is probably more useful for company comparative performance measure, where companies in the same business could be used to compare relative EPS.

EPS could be distorted by accounting policy or where share issues/buy-backs have taken place; just be careful of that.

101
Q

what is the EPS ratio formula?

A

(Net income – preference shares) / number of ordinary shares in issue

102
Q

describe Price Earnings Ratio

A

The P/E ratio provides an indication of the market’s expectation of the company’s earnings growth potential. It is the time, in years, it would take the current EPS to repay the share price. A high P/E indicates a greater perceived ability to grow EPS compared to competitors, producing higher quality/more reliable earnings, being a potential takeover target, or experiencing a temporary fall in profits.

Also known as the Earnings Multiple, the PE ratio measures how highly investors value a company as a multiple of its earnings. It is calculated by dividing the market price by the EPS, or alternatively, by dividing the market capitalisation by profits available to ordinary shareholders.

Investors pay more for shares if earnings are expected to rise; a high PE ratio (relative to other companies) shows that investors expect the company to achieve above average performance and growth.

103
Q

what are the drawbacks of the P/E ratio?

A
  • It will generally be based upon historic data (unless “forward” forecasts are used),
  • It’s only ONE number and is rather simplistic,
  • PE ratio levels must be considered relative to the sector and competitor companies, and
  • PE ratio levels should be compared to past levels and trends within an industry sector.
104
Q

what is the PEG ratio?

A

The Price Earnings Growth (PEG) ratio shows the projected growth in earnings per share in relation to a company’s share price.

105
Q

what is the P/E ratio formula?

A

P/E = Share price / EPS

A high PE ratio; market expects high growth. A low PE ratio; market expects low growth.

106
Q

what may high PEG may indicate

A
  • A share is expensive, and
  • The share has limited growth potential
107
Q

what are the disadvantages of the PEG

A

It is based on projected data / forecasts / opinions,

  • It is mainly used in conjunction with growth companies (those with fast-growing EPS),
  • Like all ratios, it is simplistic and is a single figure, and
  • It should only be used to compare companies in the same / similar sectors.
108
Q

how do you calculate the PRG ratio?

A

To calculate the PEG ratio, and investor or analyst needs to first calculate the P/E ratio of the company in question. The P/E ratio is calculated as the price per share of the company divided by the earnings per share (EPS):
P/E ratio (as above) = Price per share / EPS

Once the P/E is calculated, the PEG ratio’s formula is simply:

PEG ratio = P/E ratio / earnings growth rate

The PEG ratio is a more accurate valuation measure than the standard P/E ratio.
PEG ratios higher than 1 are generally considered unfavourable (overvalued); ratios lower than 1 are considered better (undervalued).

109
Q

what does the dividend yield indicate

A

This is an indication of the dividend income return on a share. It is a method of comparing the dividend with other investments, such as property rental income and bond yields. It also indicates ability to grow dividends in future. A low yield indicates ability for high growth and vice-versa.

The ratio compares what an investor receives as a percentage of what they have to invest (market price).

110
Q

what is the dividend yield calculation

A

Dividend yield = Dividend per share / Market price per share

Low dividend yield may indicate an overvalued share price.

High yields may indicate low growth or underrated by the market.

111
Q

what is the dividend cover

A

Dividend cover is how many times a company could have paid out its dividends based on the profit for the year, in other words a measure of the strength of a dividend payment relative to the earnings.

Dividend cover = Earnings per share / Dividend per share

The higher the dividend cover, the less likely that dividends will reduce if profits fall. Cover between 1.5 and 2 is often considered healthy, but this varies according to individual factors including industry, company size, market, etc.

112
Q

what is the net asset value per share

A

NAV per share, which is simply the net value of the company divided by the number of shares.
The statement of financial position is a list of the assets and liabilities of a company at its year-end. The total assets owned by the company and equity and liabilities (shareholders and creditors). The total assets always equal equity and liabilities.

The net asset value per share is the value of shareholders assets divided by the number of shares outstanding. A share would normally be expected to sell at a premium to its financial net asset value. Note that the “price-to-book” value ratio would be calculated as the share price divided by the net assets per share.

113
Q

what is the NAV formula

A

TOTAL ASSETS = EQUITY + LIABILITIES (this is known as the accounting equation). Net assets = total assets – total liabilities

Net asset value per share (NAV/share) =

Total net assets attributable to ordinary shareholders / number of ordinary shares in issue

114
Q

what is the price to book ratio

A

This indicates how much shareholders are paying for the net assets of the company

If trading at a discount, this could indicate share is undervalued, or the market sees it will remain a stagnant investment. If trading at a premium, this indicates the market views it has above average growth potential. In practice, most companies trade at valuations well above NAV – this becomes much more relevant when dealing with investment trusts. More on this later on!

115
Q

what is the price to book ratio formula

A

P to B ratio = share price / NAV per share

116
Q

A client of yours has come across a reference to “Covered Warrants” and has rung you up to ask about them; explain what these are

A

Covered warrants are warrants based on an underlying share which are issued by a financial institution, rather than directly by the company and are called ‘securitised derivatives’. The warrant is called ‘covered’ because the issuing institution (not the company) will hold the underlying asset, to cover its exposure.

Covered warrants are priced according to a calculation of their value; the cost of the warrants is called the premium (which represents the maximum potential loss to the holder and is the ‘premium’ over the strike price (current price)). They are exercised at the exercise price, and expire at the expiry date.

117
Q

Earnings per share (EPS) is an important and often used ratio in equity analysis. Explain what is EPS

A
  • EPS is a measure of profitability – specifically, profit available to ordinary shareholders, expressed in pence per share.
  • It is calculated as the “earnings” (net profit) divided by the total number of issued shares.

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