Ch 10: Equity and property markets Flashcards

1
Q

Define the term ordinary share

A

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

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2
Q

List eleven investment and risk characteristics of ordinary shares

A
  1. Income = dividends = share in company’s profits
  2. Capital gain may arise on sale of share
  3. Default risk depends on security of issuing company
  4. Security of capital depends on NAV, level of gearing and the risk profile of the issuing company
  5. Higher long-term expected return than government bonds
  6. Expected to provide a real return over the long term
  7. Potential for volatile markets (and dividends)
  8. Term: no fixed redemption date, generally considered to be long-term
  9. Dealing costs higher than for conventional government bonds
  10. Marketability depends on the issuing company and whether listed or not – generally worse than for government bonds
  11. Tax treatment depends on the territory
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3
Q

Describe the cashflows on an ordinary share from the perspective of the investor

A

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
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4
Q

What are the advantages of listed shares over unlisted shares to the investor

A
  1. Greater marketability
  2. Greater divisibility
  3. More information is available, due to disclosure requirements
  4. Greater security, from stock exchange regulations
  5. Easier to value
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5
Q

It is practical for analysts to specialise in one area of industry because

A
  • 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
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6
Q

What are four practical reasons for analyzing shares by industry?

A
  1. Most companies within an industry are affected by similar factors
  2. The information about these companies tends to come from a common source and is presented in a similar way
  3. No-one can be an expert in all areas
  4. It adds structure to the decision-making process
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7
Q

List three reasons for the correlation of investment performance within the same industry

A
  1. Resources
    - Companies in the same sector will use similar resources and will therefore have similar input costs
  2. Markets
    - Companies in the same sector supply the same markets, and will therefore be similarly affected by changes in demand
  3. Structure
    - Companies in the same sector often have similar financial structures and will therefore be similarly affected by changes in interest rates
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8
Q

Why are market movements the biggest influence on a share’s price

A
  1. Most companies are affected by macro-economic factors and the political climate in similar ways
  2. Most companies’ costs are affected by similar factors, eg tax, labor markets, cost of borrowing and fuel
  3. 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
  4. 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
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9
Q

Investment and risk characteristics of equities

A
  • 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
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10
Q

Quoted shares

A

Listed on a stock exchange and make up the majority of available equity investment.

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11
Q

Investment characteristics of quoted shares

A
  • more marketable
  • more secure
  • easier to value than non-quoted shares.
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12
Q

Preference share

A

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.

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13
Q

Typical features of preference shares

A
  • 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
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14
Q

Reasons for buying back shares

A
  • 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
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15
Q

List 14 investment and risk characteristics of direct property

A
  1. Risk of voids and tenant default
  2. Risk of political interference
  3. Risk of obsolescence and need for refurbishment
  4. Real return, broad hedge for inflation
  5. Higher expected return than for government bonds
  6. Income forms a ‘stepped’ patter over time
  7. Running (rental) yields varies by the type of property
  8. Volatile capital values in long term, stable capital values in short term
  9. Subjective, infrequent valuations, lack of information
  10. High dealing costs and management costs
  11. Very unmarketable
  12. Large unit size, indivisibility
  13. Uniqueness
  14. Characteristics can be changed by owner, eg redevelopment
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16
Q

On what factors would a prime property score highly?

A

CALL ST

1) Comparable properties for rent reviews and valuation
2) Age, condition and flexibility of use
3) Location
4) Lease structure
5) Size
6) Tenant quality

17
Q

Define freehold ownership of a property and outline the rights and restrictions of the freeholder

A

Freehold ownership is ownership in perpetuity.

Rights are:

  1. To occupy the building or let it out
  2. To refurbish the property of develop it

Restrictions include:

  1. Covenants
  2. Easements such as right of way
  3. Planning and building regulations
  4. Statutory requirements not to cause a nuisance to others
18
Q

Give three examples of indirect property investment

A
  1. Open ended schemes, such as property unit trusts
  2. Closed ended schemes, such as property investment trust companies
  3. Shares in property (development/investment) companies
19
Q

Outline the advantages of investment in direct property compared with investment in property company shares

A
  1. Control
  2. Diversification away from the stock exchange
  3. Forced selling and the associated loss is less of an issue
  4. Management fees to property share company advisors avoided
  5. Not exposed to high risk types of property
  6. Not exposed to extra volatility caused by gearing or the discount to NAV changing
  7. Tax advantages (possibly)
  8. Utility value
  9. Volatility of prices lower in the short term as valuations are infrequent
20
Q

Outline the advantages of investment in property company shares compared with investment in direct property

A
  1. Access to larger / more unusual properties
  2. Discount to NAV may exist – property shares may represent a ‘cheap’ way of buying property assets
  3. Diversification within the property market
  4. Divisibility
  5. Economies of scale in the case of large property share companies
  6. Expected return may be higher due to the extra volatility associated with gearing and the possibility of any discount to NAV narrowing
  7. Expenses associated with direct property investment avoided
  8. Expertise of property company managers
  9. Marketability better
  10. Quoted prices making valuations easier
  11. Tax advantages (possibly)
21
Q

Define a lease and outline how a leasehold property differs form a freehold property from an investment perspective

A

A lease is an agreement between two parties which allows one of the parties (the leaseholder) the use of a specified portion of a building owned by the other party for a specified period in return for some payment.

Leasehold differs from freehold as, typically, leasehold:

  • Has a fixed term
  • Involves a capital loss to the leaseholder at the end of the lease
  • Has a higher initial rental yield
22
Q

Payout Ratio

A

Dividends per share/Earnings per share

23
Q

Property as a hedge

A

Property is a real asset and would be expected to provide a hedge against unanticipated inflation

24
Q

Valuation (Direct Property)

A

Matter of professional judgement.
No central market with quoted prices.
There may be significant variations in valuations carried out by different valuers or by the same valuer on different bases.
Lack of information due to infrequent sales.

25
Q

Investment and risk characteristics of property to be considered:

A

M-Marketability
U- Uniqueness
S- Size
T- Type of Property (determines the running yield)

P- Political Risk
R- Real long term RETURNS (property is a real asset)
O- Obsolescence
V- Valuation
I- Indivisibility
D- Diversification
E- High Management and dealing EXPENSES

F- FORCED sales
I- stepped INCOME stream
V- Volatility
E- Expertise available

26
Q

What to consider when comparing direct to indirect property investments:

A

C- Control
E- Expenses
D- Diversification
E- Expertise

M- Marketability
E- Exposure to other sectors
E- Equity correlation for instance
T- Taxation

Volatility
Valuation
Gearing
Forced Sales

27
Q

Running Yield for Property

A

running yield= rental income (net of all management expenses) /
Cost of purchase (gross of all purchase costs)

28
Q

Net asset value per share

A

value of the company’s assets divided by the number of shares. Net assets in this definition mean assets net of liabilities

29
Q

discount or smaller discount or even premium to NAV

A

The discount to NAV reflects:
* any differences between the way in which investors value shares and the way they value property
* risk of loss on forced sale – cashflow requirements result in property companies being more likely to be forced sellers of properties than institutions undertaking direct property investment on their own account.

A smaller discount, or possibly even a premium, to NAV is possible where:
* the property company has a good management track record.
* the market has a positive view of developments giving the potential for capital gains
* the valuations underlying the NAV are conservative