4. Equities Flashcards
By law, what form of shares must a company have?
4.1 The basics
Ordinary Shares
Which documents disclose the type and number of shares in issue for a company?
There are two
4.1 The basics
-
Memorandum of association – a 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.
How can the number of shares in issue be varied?
4.1 The basics
- Share split - Increases number of shares whilst decreases the value of each share proportionally (greater liquidity + ease of sale)
- Script issue - Company offers new shares to shareholders at a discounted price
Limited liable companies?
4.1 The basics
- Listed on the stock market
- Shareholders have no liabilities to creditors/debts
- When the company makes a profit, the directors may recommend the payment of a dividend to shareholders
- Dividends can be paid interim (partway through the year) or final (end of trading year)
Cum and ex-divident
Like with bonds and interest payments, equities can be sold including the right to receive the next dividend payment
- the record-date is the cut‑off date whereby any investor buying shares after that date will not be entitled to
the forthcoming dividend.
Issuing shares - why are they issued? When are they issued?
4.2 Issuing shares
Shares are issued to rasie capital for the company.
1. Initial public offering (IPO) - Issued when the business first lists as a public company
2. When a company wishes to raise captial - often called a secondary public offering
IPO - What are the two ways that this is arranged?
What is a requirement?
4.2 Issuing shares
- Offer for sale - Fixed price, Tender (which works well for smaller companies - effectively an aution), Subscription (Similar to Tender, but company is not compelled to accept low offers and is therefore not underwritten…making it cheaper)
- Placing - Company offers shares directly to stockbroker
- It is a requirement that 25% of a companies shares be owned by the general public
There are 2 main ways an existing company can raise capital - placing, and …
What is ‘tail swallowing’
4.2.2 Raising capital
A rights issue
* Offer to exisiting shareholders to buy new shares in proportion to the number of shares they already held. These are offered at a discount.
* The shareholder does not pay any money to obtain the right to buy the shares, but will have to pay the quoted rights price to exercise it - therefore this right has value and can be traded.
* Most rights issues are fully underwritten to ensure the required capital is raised, although this can add significantly to the cost of raising the capital.
‘Tail swallowing’ is a term used when the shareholder sells enough nil-paid rights to pay
for them to exercise some of their rights to buy new shares.
Adjustment issues - what? list the two kinds?
And adjustment of the share capital - either to expand or to improve liquidity (i.e. one share of £50 is harder to sell than five shares of £10).
* Share split
* Scrip issue
What is a Share split?
Where a company wishes to adjust its share capital:
A share split is used to lower a company’s share price to make it more attractive to investors and improve liquidity. In a share split, each existing share is divided into multiple smaller shares, reducing the par value but not affecting the total value of the investment.
For example, a share with a 20p par value might be split into four shares with a 5p par value each.
What is a Scrip Issue?
Where a company wishes to adjust its share capital:
A scrip issue allows a company to transfer money from shareholders’ reserves to its share capital by issuing new shares at no cost to shareholders. These new shares are issued in a set ratio, like “one for one,” meaning shareholders receive additional shares but maintain the same proportion of ownership
The share price adjusts downward proportionally to the new number of shares, so the total value of each investor’s holding remains unchanged.
Types of share - Ordinary Shares
- Basic Share Type: Ordinary shares are the default type every company must issue.
- Voting Rights: Usually, one vote per share at the annual general meeting (AGM).
- Dividends: Shareholders may receive dividends if declared, but no guarantee of payment or the amount.
- Winding Up: Ordinary shareholders are paid last if the company is wound up, and only if there are funds remaining.
- Liquidation: Shareholders have no further liability unless shares are only part-paid; they must then pay the remaining balance (unpaid call).
- Incentives: Shareholders may receive discounts on company products.
Types of Shares - preference shares
Dividends compared to ordinary shares
- Preference Shares: Issued in addition to ordinary shares, similar to loan stock.
- Dividends: Pay fixed dividends, usually every six months, if enough profit after tax is available.
- Winding UpRank ahead of ordinary shares for dividend payments and repayment if the company is wound up.
Fixed Dividend: Lower than ordinary share dividends, making preference shares less risky.
* Capped Dividend: Fixed dividend is beneficial when profits are low, but not ideal when profits are high since it doesn’t increase.
- Non-Cumulative:If there isn’t enough profit, no dividend is paid, and the missed dividend is lost.
- No Voting Rights: Preference shareholders don’t usually have voting rights unless dividends are in arrears.
Cumulative, Participating, and Convertible preference shares:
Cumulative Preference Shares: Pay the current year’s dividend plus any missed dividends from previous years.
* Priority: Missed and current dividends are paid before ordinary shareholders receive any dividend.
Participating Preference Shares: Pay a fixed dividend plus an additional dividend based on a portion of the company’s profits.
* Extra Dividend: Usually linked to a percentage of the ordinary share dividend.
Convertible Preference Shares: Offer lower dividends than regular preference shares.
* Conversion Right: Can be converted to ordinary shares at a set price and date.
* Higher Price: Typically trade at a higher price than ordinary shares.
* Limited Option: If not converted by the set date, the option expires.
What is a warrant?
Gives the owner the right to subscribe for a given number of ordinary shares
Warrant holders do not have rights to dividends because they do not own any shares.
The main market and the AIM - main points
4.4 The markets
Main Market - allowas companines to be quoted on the Stock exchange
* Requirements: Companies must meet strict FCA rules on prospectus, listing, and transparency.
* Full Listing: Requires at least 3 years of trading and 25% of shares in public hands.
* Free Float: Refers to publicly traded shares not held by insiders or controlling investors, and it’s used to help calculate market capitalization.
AIM Overview: a separate market on the London Stock Exchange, mainly for small, growing companies.
Purpose:** Helps companies raise capital through share issuance and provides a platform for trading shares while boosting their public profile.
**Less Stringent Rules: AIM has fewer regulations than the main market, but is more suitable for experienced investors due to higher risks.
What are unlisted securities? And what are the benefits of them to an investor?
3 forms of relief
Shares in companies too small even for the AIM
- Capital Loss Relief: Losses from unlisted securities can be set against other income if shares were subscribed to, not transferred. Shares must be in qualifying trading companies for EIS relief (since 6 April 1998).
- Interest Relief: Tax relief is available for loans used to buy shares in close companies if the investor owns more than 5% of shares or works in management. Relief is not available if EIS tax relief has been claimed on those shares.
- Inheritance Tax Relief:100% business property relief applies to shares in unlisted or AIM-listed companies held for at least two years.
What are the 4 features that determine a shares value to an investor?
- Dividend yield – an indication of the income;
- Price–earnings ratio – an indication of growth;
- Net asset value – an indication of the risks underlying the company;
- Dividend cover – an indication of continuing dividends.
What is a share’s dividend yield? and how is it calculated?
A measure of income received vs share’s current market price.
Calculation
(net dividend ÷ share price) x 100
Example: Net dividend 5p per share; current price £1.45. = 3.45%
Useful, but based on historical data - last years divs.
What is a share’s dividend cover? and how is it calculated?
Dividends and EPS: Dividends are paid from profits, often expressed as earnings per share (EPS). For example, £1m profit with 10m shares gives an EPS of 10p.
Dividend Cover: This shows how many times profits can cover the dividend. It’s calculated by dividing EPS by the net dividend. For example, with 10p EPS and a 2.5p dividend, the dividend cover is 4.
Indicator of Stability: A high dividend cover means the company is likely to continue paying dividends. A low cover, especially below 1, suggests dividends might come from reserves, putting future payments at risk.
Calculated by dividing the EPS by the net dividend
What is a share’s price per earning ratio? What does it show?
P/E Ratio: The price/earnings (P/E) ratio is the share price divided by earnings per share (EPS). It shows how much investors are paying for each unit of earnings.
High P/E: A higher P/E suggests greater market expectations for future growth (growth stocks), but doesn’t necessarily mean the share is a better investment—optimism may already be priced in.
Sector Comparison: P/E ratios should be compared within the same sector, as different industries have varying levels of confidence and growth expectations.
Price earnings to growth ratio (PEG) - what is the limitation with P/E? What does PEG show and how is it calculated?
PE Ratio Limitation: Companies with higher growth rates often have higher PE ratios, which can suggest overvaluation, but this isn’t always true.
PEG Ratio: The PEG ratio compares price, earnings, and expected growth to determine the true value of a stock. A PEG of 1 indicates the stock is fairly priced for its growth, while a PEG below 1 suggests the stock may be undervalued.
Negative PEG: A negative PEG might signal a decline in earnings, though there could be other valid reasons.
Calculated by:
Price per earnings ÷ Annual Earnings per share
What is Net asset value? what does it show? How is it calculated? When is it particularly important?
Net asset value (NAV) is the market value of all of a company’s assets, less liabilities, divided by the number of shares issued.
Shows general reliability and trustworthiness of a company - unlike to default.
NAV helps investors determine whether a share is trading at a discount (below NAV) or a premium (above NAV) relative to its intrinsic value - and hence shows investment oppurtunty.
Importance of NAV: NAV is particularly significant for investment trusts and property companies.
What is gearing? Give an example. What is the implication of high gearing?
Gearing: This measures a company’s long-term borrowing relative to its shareholder capital and reserves. It is calculated by dividing long-term debt by capital and reserves.
Example: If a company has £100,000 in long-term borrowing and £200,000 in capital and reserves, its gearing is 50%.
Components of Long-Term Borrowing: This includes loans with terms over 12 months, preference shares, debentures, and loan stock.
Implications of High Gearing: A highly geared company relies heavily on borrowing, which can be risky if interest rates rise or profits fall. However, it can also enable investment and potentially enhance performance if the company succeeds.
