Ch 10: Equity and property markets Flashcards
Define the term ordinary share
Ordinary shares are securities held by the owners of an organization
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 right to attend and vote at general meetings of the company
List eleven 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 listed or not – generally worse than for government bonds
- Tax treatment depends on the territory
Describe the cashflows on an ordinary share from the perspective of the investor
Share purchase:
- An initial lump sum negative cashflow equal 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, and 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 subsidize dividends in poorer years.
Final payment:
- There is no redemption payment – dividends can be assumed to continue indefinitely
- However, there will be a final positive cashflow, which is unknown in amount and timing 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
It is practical for analysts to specialise in one area of industry because
- Factors affecting one company within an industry are likely to be relevant to other companies in the same industry
- Information for companies in the same industry will come from a common source and be presented similarly.
- No one analyst can expect to be an expert in all areas, so specialisation is appropriate.
- The grouping of equities according to some common factor gives structure to the decision-making process. Assists in portfolio classification & management
What are four practical reasons for analyzing shares by industry?
- Most companies within an industry are affected by similar factors
- The information about these companies tends to come from a common source and is presented in a similar way
- No-one can be an expert in all areas
- It adds structure to the decision-making process
List three 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 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
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, eg 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 then 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
Investment and risk characteristics of equities
- Security depends on profitability of the company
- Provide a long-term real yield as companies grow in
line with inflation, dividends tend to grow in line with
GDP - Higher expected returns than government bonds
over the long term - Income and capital values can be volatile
- Equities can generally be held in perpetuity
- Dealing expenses are linked to marketability
- Marketability depends on the size of the company
Quoted shares
Listed on a stock exchange and make up the majority of available equity investment.
Investment characteristics of quoted shares
- more marketable
- more secure
- easier to value than non-quoted shares.
Preference share
A particular class of share that generally ranks ahead of ordinary shares.
Normally entitled to a specified rate of dividend, and, unlike ordinary shareholders, not to residual profits.
Typical features of preference shares
- dividend on a preference share is usually a fixed percentage of the par value and is always paid before any distribution to 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-efficient than dividends
- Company may wish to change capital structure 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’ patter 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, eg redevelopment