Ordinary Share
share in the ownership of a company
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.
Why are shares grouped by industry sectors
- practical for analysts to specialise in one area
- share prices of companies in the same sector tend to be correlated
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
Shares of companies in the same sector are correlated because… (3)
- Use the same resources, have similar input costs
- supply to the same market, similarly affected by demand
- Similar financial structures, ie influenced by changes in interest rates.
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
Cumulative property of preference shares
If a dividend is unpaid, the arrears must be paid off before any payment is made to ordinary shareholders
Payout Ratio
Dividends per share/Earnings per share
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
SYSTEM T
Security Yield Spread Term Expenses and Exchange rate Marketability
Tax
Property
A legal title to the use of land and buildings.
Direct property investment
Involves the purchase and management of tangible assets.
- Are large and indivisible.
Indirect property investment
Investment via shares in property companies or units in a pooled property fund.
Prime property
Property most attractive to investors. Score highly on: S - Size T - Tenant quality A - Age & condition L - Location L - Lease structure
C - Comparability
Property as a hedge
Property is a real asset and would be expected to provide a hedge against unanticipated inflation
Marketability of property
Very unmarketable
It can take a long time to buy or sell and dealing costs are high.
3 Characteristics that make property unmarketable
- Unit size
- Uniqueness
- Valuation
Unit size (Direct Property)
Unit size of most property investment is large and in general, single properties are indivisible.
Uniqueness (Direct Property)
Each property is unique.
Makes it harder to value, reduces marketability.
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.
Security of property income
- Depends on the quality of the tenant.
- Rent payable by a company is a prior charge on its profits, but costs of recovery from tenants in arrears can be high
- There is a risk of “voids” - periods when the property is not let.
Obsolescence (Property)
Slowdown in the relative rate of growth in value between old and new buildings.
Need for modernisation: large expenditure.
Susceptible to government intervention such as rent and planning controls.
Spread (Direct Property)
Capital values of buildings can be volatile over the longer term, although infrequent valuations and stable valuation methods reduce short-term volatility.
Yield (Property)
Property is less marketable & less secure than index-linked government bonds.
Investors thus require a higher return from property.
Expenses (Direct Property)
Property management cost are high even if the tenant is responsible for building maintenance and insurance.
Freehold ownership (Property)
Ownership in perpetuity.
Freeholder has the right to occupy the building, let it out, and refurbish the property or develop it.
There may be restrictions, ex covenants, easements such as rights of way, planning and building regulations & statutory requirements not to cause a nuisance to others.
Easements (Property)
specific rights acquired by someone other than a landowner or tenant.
Unencumbered freehold (Property)
No existing tenant, ie freeholder may choose to:
- add value by re-developing and/or refurbishing
- set up a lease and receive rents
Leased freehold (Property)
Already has a tenant, so that the investor will receive the rents due under the terms of the existing lease, plus reversion of the unencumbered freehold at end of lease.
5 Disadvantages of direct property holdings
- Size
- Diversification
- Lack of marketability
- Valuation
- Expertise needed
Advantages of direct property investment
- Diversification of overall portfolio (property shares are subject to movements in equity market)
- Volatility (less volatile than property shares)
- Control over property portfolio management
- Loss on forced sale unlikely
- Exposure (property company may invest in buildings under construction, multiple risks associated)
Advantages of indirect property investment
- Diversification within the property market (property companies offer greater spread of risk)
- Market prices / performance measurement - no visible market price for real property.
- Marketability - property shares are more marketable than direct investments.
- Management expertise (company can afford expertise)
- Advantage of size (large companies may invest in large properties, too big for direct investors)
Financial Gearing w.r.t. property investment
Commercial property investments often provide secure income streams, making property investment / development companies ideal vehicles for financial gearing.
Discount to net asset value w.r.t. property investment
property shares usually stand at a discount to NAV.
Property assets may be purchased cheaply.
Investment and risk characteristics of property to be considered:
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
What to consider when comparing direct to indirect property investments:
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
