Shareholders Flashcards
Share Definition
Shares represent the proportion of a company owned by an investor. Also called equity.
Proportion of Business Owned
No. of shares owned
——————————- x 100 = % owned
Total shares issued
Ordinary vs. Preference Shares
Ordinary shares get voting rights and a dividend
Preference shares get a set dividend amount before ordinary shares get theirs. No voting rights.
Shareholder Objectives
Main objective for most private companies is to maximise the wealth of its shareholders.
Done by maximising profits and either paying dividends or reinvesting profits into the business to raise share price.
Return on Capital Employed (ROCE)
Shows how efficient a company is at generating profits from the amount invested.
Shareholders compare ROCE to their expectations in order to make investment decisions
ROCE Formula
Profit before interest and tax
—————————————— x 100%
Total assets - current liabilities
ROCE for Investment Decisions
ROCE is above expectation:
Yes - invest
No - consider alternatives
ROCE is higher than an alternative investment:
Yes - invest
No - move money
ROCE Failures
Doesn’t take into account where profits go. If ROCE is high, but tax and interest are too, dividend will be smaller than expected
Earnings Per Share (EPS)
EPS calculates potential dividend payout per share.
Actual dividend may be lower if the directors decide to reinvest profit .
EPS Formula
Number of outstanding ordinary shares
Long Term Shareholder Wealth
To calculate expected return over a given period, a shareholder could total up expected:
- dividends over the period; and
- increases in price per share
Issues with Expected Returns
Estimated values may differ from actual values
Doesn’t take cost of capital into account
Shareholder may not know their cost of capital - return level required
Ignores the time value of money
Secure more jobs
Net Present Value
Alternative approach. Works out the value of the company.
Based on cash flows (increased cash flows = increased value)
Takes into account cost of capital and time value of money
Factors Affecting Long Term Value of Shares
Internal factors: things the company does
External factors: things competitors/outsiders do
Financial factors: company financial results
Market expectations, positive and negative info also affect share value
Risk and Return - Types of Risk
Systematic: uncertainty inherent to a particular market, e.g. the property market
Unsystematic: uncertainty inherent to a company
These risks are avoided by investing in a bank instead of shares.
Banks vs. Shares
Banks:
- Interest consistent and guaranteed
- Investment in the bank stays the same
- Often guaranteed by the government
Shares:
- Annual dividends will vary each year
- Market value of shares varies
- Investors lose full investment if co closes
Risk vs. Return - Risk Free Rate
Rate of return which would satisfy investors if they were guaranteed a return e.g. at a x% return, risk is 0 on the graph.
Based on:
Rate required to compensate being unable to spend the money now; and
Rate of inflation
Factors Affecting Risk and Return
Company Strategy
- Returns may be low if profits reinvested
- Shareholders may accept lower short term returns for high returns following investment
Factors Affecting Risk and Return
Economic Conditions (During Recession)
- Profits fall so investing is riskier, investors expect a higher return
- Returns available fall so investors may accept lower levels of returns
Factors Affecting Risk and Return
Expectations About the Industry
- High returns in one industry push up rate of returns across the whole industry, so expectation rises.
Shareholder Impact on Management
Management have to keep shareholders happy to ensure continued investment.
Dividend Policy
Determination of how much and how often cash is paid out of profits as dividends.
Every policy must consider the other financial needs of the business as well as:
- Shareholder cost of capital; and
- Level of risk shareholders want to take
Signalling
Dividend announcements convey information to the market affecting share prices.
Management will tend to choose projects which promise positive announcements.
Shareholder Communication
To limit negative reactions from assumptions, organisers can keep contact with shareholders through:
- Holding shareholder meetings
- Communicating all project decisions
- Communicating all dividend announcements
