Chapter 10: Equity and property markets Flashcards
(27 cards)
Define the term ordinary share
Ordinary shares are securities held by the owners of an organisation
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 a company.
Investment and risk characteristics of ordinary shares (equity)
- Security: The security of the dividend income will depend on the company issuing the shares (dividend cover)
- Yield (real vs nominal): Expected to provide a real return over the long term
- Yield (Expected return relative to other assets): More risky than bonds, so higher expected return
- Spread: Potential for volatile markets and dividents (supply & demand)
- Term: no fixed redemption date, generally considered to be long-term
- Expenses: Dealing costs higher than for conventional government bonds
- Exchange rate - currency risk: equities avialable overseas
- Marketability: depends on the issuing company and whether listed or not (generally worse than for government bonds)
- Tax: depends on the territory
Describe the cashflows on an ordinary share from the prespective of the investor
Share purchase:
-Initial lump sum negative cashflow equal to the price paid for the share plus dealing expenses
Dividend payments:
* 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 are 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, expansins or subsidize dividents in poorer years
Final payment:
There is no redemption payment - dividends can be assumed to continue indefinetly
* However, there will be a final positive cashflow, which is unknown in amount and timing if:
1. The investor sells the share or 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 avialable, due to disclosure documents
- 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 llikely to be relevant to other companies in the same industry
- Information for companies in the same industry will come from a common source an 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 decision-making process. Assisits in portfolio classification & management
List 3 reasons for the correlation of investment performance within the same insustry
- 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 e.g. 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 than 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
Quoted shares
Listed on a stock exchange and make up the majority of avialable equity investment
Investment characteristcs 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 usually 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
Investment and risk characteristics of direct property
- Security:
-Risks of voids and tenant defaults
-Risk of political interference
-Risk of obsolescence and need for refurbishment - Yield (real vs nominal): Real return, broad hedge for inflation. Income forms a stepped pattern over time
- Yield (expected return relative to other assets): Higher expected return than for government bonds (less marketable and less secure)
- Spread: Capital values of buildings can be volatile over the long term, but land is indestructible so always will have some value
- Expenses: High dealing costs and management costs
- Marketability: very unmarketable (Unit size, uniqueness, valuation)
- Characteristics can be changed by owner, e.g. redevelopment
On what factors would a prime property score highly?
CALL ST
* Comparable properties for rent reviews and valuation
* Age, condition and flexibility of use
* Location
* Lease structure
* Size
* Tenant quality
Define freehold ownership of a property and outline the rights and restrictions of the freeholder
Freehold ownership is ownership in perpetuity.
Rights:
* To occupy the building or lent it out
* To refurbish the property or develop it
Restrictions:
* Covenants
* Easements such as right of way
* Planning and building regulations
* Statutory requirements not to cause nuisance to others
Give 3 examples of indirect property investment
- Open ended schemes, such as property unit trusts
- Closed ended schemes such as property investment trust companies
- Shares in property (development / investment) companies
Outline the advantages of investment in direct property compared with investment in property company shares
- Control
- Diversification away from the stock exchange
- Forced selling and the associated loss is less of an issue
- Management fees to property share company advisors avoided
- Not exposed to high risk types of property
- Not exposed to extra volatility caused by gearing or the discount to NAV changing
- Tax advantages (possibly)
- Utility value
- Volatitlity of prices lower in the short term as valuations are infrequent
Outline the advantages of investment in property company shares compared with investment in direct property
- Access to larger / more unusual properties
- Discount to NAV may exist - property shares may represent a “cheap” way of buying property assets
- Diversification within the property market
- Divisibility
- Economies of scale in the case of large property share companies
- Expected return may be higher due to the extra volatility associated with gearing and the possibility of any discount to NAV narrowing
- Expenses associated with direct propery investment avoided
- Expertise of property company managers
- Marketability better
- Quoted prices making valuations easier
- Tax advantages (possibly)
Define a lease and outline how a leasehold property differs from a freehold property from an investment prespective
A lease is an agreement between two parties which allows one of the parties (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
Payout ratio
Dividends per share / Earnings per share
Property as a hedge
Property is a real asset and would be expected to provide a hedge against unanticipated inflation
Valuation (Direct Property)
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.
Investment and risk characteristics of property to be considered:
MUST PROVIDE FIVE
* Marketability
* Uniqueness
* Size
* Type of Property (determines the running yield)
- Political Risk
- Real long term returns
- Obsolescence
- Valuation
- Indivisibility
- Diversification
- Expenses
- Forced sales
- Income stream
- Volatility
- Expertise avialable
What to consider when comparing direct to indirect property investments:
CEDE MEET VVGF
- Control
- Expenses
- Diversification
- Expertise
- Marketability
- Exposure to other sectors
- Equity correlation for instance
- Taxation
- Volatility
- Valuation
- Gearing
- Forced Sales
