Chapter 10 - Equity and property markets Flashcards
What is the payout ratio?
Dividends/Earnings
What is an alternative way to pay shareholders, other than dividends? Why would a company want to do this instead of paying dividends? (4)
Share buybacks.
May have excess cash it cannot use profitably.
Improve the earnings per share ratio, if return earned is not worth holding the money.
Could be a tax-efficient means of returning capital to shareholders.
Switch capital structure from equity to debt financing.
Discuss the risk characteristics of ordinary shares.
Security
- Depend on issuing company
- Stability of profits
- Ratio of earnings to dividends
- Will receive residual assets on winding up (after creditors are paid)
- Will also depend on if listed due to heavy requirements of financial reporting and disclosure of information
Yield - real vs nominal
- Have provided real returns in the long run historically since company profits (and therefore div) tend to rise with inflation and economic growth
- No guarantee of this
Yield - compare to other assets
- Higher perceived risk than most asset classes and therefore expect higher return to compensate
- Depends on issuing company
Spread
- Prices and dividends can be volatile
Term
- Can theoretically be held in perpetuity
Expenses
- Linked to marketability
- Main expense in active trading is spread between buying and selling prices
Exchange rate
- Currency risk if investing in overseas equities (with different currency to that of liabilities)
Marketability
- Depends on issuing company
- Larger company generally means better marketability
- Will also depend on if company is listed
Tax
- Income (div) and capital gains (change in share price) may be taxed differently
- May also depend on the investor (eg pension company)
- May be different for quoted vs unquoted shares
What is the dividend coverage ratio?
Earnings/Dividends
How can equities be grouped into categories?
Size of company
Expected profits growth
Industry
What are the benefits of categorisation by industry?
Practicality
- Information will come from a common source and be presented in a similar way
- Specialisation is possible
- Assist portfolio management and decision-making process
Correlation of investment performance
- Factors affecting one company are likely to affect others win the industry similarly
- Relevant factors include
1 ) such as resource availability and price
2) markets (demand)
3) financial structure (change in interest rates)
What are the difficulties related to grouping equities by industry?
Companies may operate in several industries.
Heterogeneity of companies within particular sectors
What are the factors to be considered when evaluating the value of property? (6)
Location Age and condition Quality of tenant Number of comparable properties for rent review and valuation purposes Lease structure Size
What additional risk characteristics does property have to the SYSTEM T acronym?
Unit size
Risk of obsolescence
Ability to change characteristics of the property
Utility value
What is an upward only rent review?
Level of rent can never be reduced (only held the same) at each rent review.
What is rack rent?
Rent that would be charged if an immediate open-market rental review were conducted for the building.
What is the formula for running yield for property? What does it tell us?
(rental income - management expenses)/(cost of purchase + associated purchase costs)
Tells us how much of the return is earned through income as opposed to capital growth.
Discuss the risk characteristics of direct property investment.
Security
- Depends on quality of tenant
- Possibility of voids where no rental income is earned
- Susceptible to government intervention such as rent and planning controls
Yield - real vs nominal
- Rent and property value should move broadly in line with inflation (rent reviews)
Yield - compared to other assets
- Relatively risky and low marketability means greater expected return than conventional bonds, ILB and MMI, possibly lower than shares.
Spread
- Capital values can be volatile in the long run
- Infrequent valuations and stable valuation methods reduce short-term volatility
- Values tend to move in cycles, lagging behind the general economic cycle.
- Higher site value (location value) will make property value more stable.
Term
- Depends on lease
- Can be short to very long term
Expenses
- Costs of arrears recovery can be high
- High management costs (rent collection and review, valuation)
- High dealing expenses
Marketability
- Can be highly unmarketable due to lack of divisibility
- Each property is unique making it harder to value
- Could be large differences in valuations due to subjectivity and lack of information
Tax
- Property tax and income tax on rent
Ability to change risk characteristics
- Depends on owner
Unit size
- Large units may be less marketable due to lack of divisibility
Risk of obsolescence/depreciation
- Depends on property use and location
Utility value
- Owner may be able to use property themselves which offers value
What are the main disadvantages of investing in direct property which are addressed by investing in indirect property? (6)
Size could be too large Diversification is difficult/impossible within the property market Lack of marketability Valuation issues Expertise is needed
What are the three main ways of investing in property indirectly?
Pooled property funds
- Open-ended unitised funds
- Closed-ended investment trusts
Property company shares
- Property developers
- Property investors
Listed Real estate investment trusts (REITS)
