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Equities Part 1 Overview and Principles

Learn the basics of shares and bonds, compare their risks and rewards, and explore topics like share buybacks and rights issues in this comprehensive financial training.

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Equities Part 1 Overview and Principles

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  1. Equities Part 1Overview and Principles 2019/2020 Audley Financial Training

  2. What we’re going to cover • The basic concept of shares • The comparison between shares and bonds • The main risks and rewards of investing in shares • Share buy backs and Rights issues Audley Financial Training

  3. Back to basics • Shares are one of the two main ways for a company to raise capital. • Shares are offered to the public through an Initial Public Offering (IPO) • They are then traded on a recognised exchange • Shares have no redemption date • As part owners of the company, shareholders can receive a share of the profits in the form of a dividend Audley Financial Training

  4. Risk and reward of shares • Shareholders have the possibility (not the right) to receive dividends. • This gives an element of inflation protection since dividends should increase if the company’s profits rise • But dividends can fall or be suspended. • The market price of shares will also vary and should the business fail and the shares become worthless Audley Financial Training

  5. Shares v Bonds: Investors’ perspective • No underlying value • More volatile than bonds • Dividends aren’t guaranteed • But should increase in line with profits. • Have an indefinite life. • Shareholders have a say in the running of the company • Have an underlying value. • Less volatile than shares • Interest payments are fixed and can’t increase • Default risk • Have a fixed term • Have no say in the running of the company Audley Financial Training

  6. Risk premium Equities C Bonds Lower than AAA UK Gilts AAA rated bonds Excess return required by investors in return for taking additional risk Audley Financial Training

  7. Shares v Bonds: company perspective • No obligation to pay dividends • Does not have to pay back the shareholders. • Shareholders have a say in the running of the business • Must pay interest when due. • Must repay the loan • Easier to arrange a new loan rather than issue new shares • Bondholders have no say in the running of the business Audley Financial Training

  8. Tesco Bond v Tesco Shares • If held to maturity, £10,000 invested in the Bond will pay the holder £4,250 in interest plus return of £10,000 • £10,000 would have bought about 3,125 shares. • He would have received £1,300 in Dividends (no dividend paid between 19/12/14 and 24/11/17 • The price on 23/5/19 was 242.50p so its value was £7,217 Audley Financial Training

  9. Not all shares have the same risk • Whilst shares are more volatile than Bonds, not all shares carry the same amount of risk. • Utility shares, e.g. water, electricity, gas companies should provide a steady source of income/dividends • Newer start up businesses will probably be more volatile than older established ones. • Shares in overseas companies or UK companies with substantial overseas earnings will be subject to currency risk. • Smaller companies or shares on the AIM may be less liquid Audley Financial Training

  10. Share Price £5 Market Capitalisation £5 x 1 Billion = £5 billion Rights issue Acme Widgets PLC 1 Billion shares issued Share Buy Back Audley Financial Training

  11. Share Buy Back • The company starts to buy back its own shares. • This reduces the number of shares. • The profits per share will therefore increase • It could lead to an increase in the share price. • BUT the company may be criticised because it could use these resources for investment Audley Financial Training

  12. Rights issues • Companies can raise further capital by offering new shares to its shareholders • These will be priced at a discount to current market price • Once the shares are issued the number of shares is increased • This will dilute the shareholding and reduce the price of the shares. Audley Financial Training

  13. Acme Widgets shares are trading at 500p. It has a rights issue offering 1 new share for every 4 held at 300p The post issue price would be 1,000 shares £5,000 250 shares £750 1,250 shares £5,750 £5,750/1,250 = 460p Ann holds 1,000 shares so she has the right to buy 250 shares If she exercises her right she will have 1,000 shares @ 500p = £5,000 250 shares @ 300p = £750 If Ann didn’t exercise her rights her holding would be worth 1,000 shares @ 460p = £4600 Audley Financial Training

  14. Scrip and bonus issues • To increase liquidity companies may split the number of shares • Splitco shares are trading at £20. The company changes is share structure so replaces the current share with 4 shares. The price of the new share is now £5. The value of the individual’s shareholding is unchanged. • A Bonus Issue is similar but 4 extra shares are issued for every share held. • The value of the shareholder’s remains the same Audley Financial Training

  15. What we’ve covered • The basic concept of shares • The comparison between shares and bonds • The main risks and rewards of investing in shares • Share buy backs and Rights issues Audley Financial Training

  16. Equities Part 2:Technical Analysis 2019/20 Audley Financial Training

  17. What we are going to cover • What is meant by technical analysis and how it differs from fundamental analysis • The main performance measures of shares, Earnings per share, price earnings ratio, dividend cover and dividend yield • The basics of chart analysis including Moving Day Averages and Relative Strength Indicator Audley Financial Training

  18. What determines the price of a share I’m willing to buy shares in Bigco for 125p a share I’m willing to sell shares in Bigco for 125p a share For every buyer there must be a seller Audley Financial Training

  19. How to assess a share’s value • Technical analysis • Considering the key indicators of a share price in relation to the company’s profits and dividend • Both as a “snapshot” and over a period of time • Fundamental analysis • Considering the company’s overall performance with emphasis on interpreting its financial accounts Audley Financial Training

  20. Technical analysis Profits available to shareholders Bond Holders Key Inputs Key Outputs Share price Price earnings ratio Dividend Cover Dividend yield Dividend Earnings per share Dividend Audley Financial Training

  21. Technical Analysis: Earnings per share • The aim of a company is to make a profit • Bond-holders have first claim on the profits • What is left are the profits attributable to share holders • If we divide these by the number of issued shares we get the earnings per share (EPS) • 1 million shares, profits attributable to shareholder £250,000 • EPS = 25p Audley Financial Training

  22. Price/earnings ratio EPS 50p Company A Share price 500p Payback 10 years EPS 25p Company B Share price 500p Payback 20 years Audley Financial Training

  23. Price Earnings ratio Price/EPS Shares trading at 10 times its earnings Company A 500p/50p = 10 Company B 500p/25p = 20 Shares trading at 20 times its earnings Audley Financial Training

  24. Interpreting Price/earnings ratio • Is company A (p/e 10) undervalued or is B (p/e 20) overvalued? • Is the market more confident about B than A? • Is it misleading? Share price of B may have fallen because of a profits warning but EPS would still be the same. • A p/e of 14 to 20 is fairly typical • What would you make of a p/e of 164.63? • M & S (December 2018) 291.40/1.77p Audley Financial Training

  25. Price Earnings Growth ratio (PEG) • A variation on the PE ratio • Formula is PE/anticipated growth • PE is 14, anticipated growth is 7% • PEG is 2 Audley Financial Training

  26. Dividend Cover Company B EPS 36P Company A EPS 36P How sustainable is the current dividend? Dividend cover = EPS/Dividend Dividend 12p Dividend 24p 36p/24p = 1.5 36p/12p = 3 Audley Financial Training

  27. Dividend Yield • Formula is Dividend/share price x 100 • Share price 180p • Dividend 8.1p • Yield is 8.1/180 x 100 = 4.5% Audley Financial Training

  28. To sum up • Price Earnings ratio: Share price/earnings per share • Measures market’s confidence in the company • A high p/e ratio may indicate market confidence • Dividend Cover: EPS/Dividend • Measures ability of company to sustain dividend • Higher the number the better • Yield: Dividend/share price x 100 • Gives a comparison with other investments Audley Financial Training

  29. Moving day Average • Measures the average closing price of a security over a given period of time. • The most common are 50 and 200 days • When the trend is rising that tends to indicate a “bull” market • This is strengthened if the short term trend is higher than the long term trend. • But if the short term trend falls below the long term trend, this may indicate a “bear market” Audley Financial Training

  30. Relative strength indicator (RSI) • A mathematical formula that measures the number of days an index or security rose or fell over a period of time. • It is a figure ranging from 0 to 100 • If it is below 30 it indicates the security may be undervalued • Over 70 it may be overvalued • But not always accurate since a large surge or fall may give a false figure Audley Financial Training

  31. To sum up • You should now know: • What is meant by technical analysis and how it differs from fundamental analysis • The main performance measures of shares, Earnings per share, price earnings ratio, dividend cover and dividend yield • The basics of chart analysis including Moving Day Averages and Rolling Strength Indicator Audley Financial Training

  32. Equities Part 3Fundamental Analysis 2019/20 Audley Financial Training

  33. What we are going to cover • What is fundamental analysis • Share classification • Basic company accounts • Key financial ratios Audley Financial Training

  34. Fundamental analysis • Focus is on the company itself • Based on the premise that the shares of a successful company will outperform those of a struggling one. • The skill is to be able to identify future rather than current performance. • How the share price might react to different economic conditions. • Interpretation of company accounts Audley Financial Training

  35. The business cycle Audley Financial Training

  36. Types of share Cyclical Non-Cyclical Not linked to the economy Defensive Linked to the economy Agressive Audley Financial Training

  37. Basic Company Accounts • Profit and Loss Account • Balance Sheet • Cashflow Statement Audley Financial Training

  38. Profit & Loss Account • Records income and expenditure over a set period • Gross Profit is Turnover less cost of sales • For the exam two key measures • Profit before interest and tax (PBIT) • Profit after interest and tax Audley Financial Training

  39. Basic Profit and Loss account Audley Financial Training

  40. Balance Sheet • A snapshot of the company’s assets and liabilities (usually on last day of trading year) • Fixed assets are things like buildings and plant. They cannot be sold off easily • Current assets are items that could be realised quickly. Includes cash, stock and money owed to the company • Long Term Liabilities are long term loans • Current liabilities are debts that have to be repaid in the short term such as overdrafts and money owed by the company • The difference is the equity or shareholder’s funds Audley Financial Training

  41. Basic Balance Sheet Audley Financial Training

  42. Key financial ratios • Return on Equity • Return on Capital Employed • Debt equity ratio (Gearing ratio) • Interest Profit ratio • Working Capital • Acid test or Liquidity ratio Audley Financial Training

  43. Good profits do not a good investment make • I own a restaurant • Sales are £400,000 and profits are £80,000 • The profit ratio is 20% (£80,000/£400,000) • BUT I invested £4 million • So the return on my investment is 2%( £80,000/£4,000,000) Audley Financial Training

  44. Return on Equity (ROE) Profit after Interest and Tax Shareholders’ Funds Issued Share Capital Share Premium Account Retained Profits Gives you a benchmark to compare return on this investment to alternatives Audley Financial Training

  45. Return on capital employed (ROCE) Profit before Interest and Tax Debt + equity Tells investors how well the company is using its capital Audley Financial Training

  46. ROCE examples Company A PBIT £6m. Debt + Equity £40m ROCE = 15% Company B PBIT £3.6m. Debt + Equity £38m ROCE = 9.47% Audley Financial Training

  47. Debt/Equity ratio a.k.a. Gearing Ratio Debt equity Equity Debt Loans + Preference Shares Audley Financial Training

  48. Debt/equity example • Debt is £1m • Equity is £2m • Debt equity is 0.5 • For every £1 of debt there is £2 of equity • Debt is £1m • Equity £1.4m • Debt equity is 0.71 • For every £1 of debt there is £1.4 of equity Audley Financial Training

  49. How easy is it for the company to pay the interest on its debts? Profit before interest and Tax Gross Interest £1 million/£200,000 = 5 This company is finding it easy to pay the interest and should be able to bear any increase in rates £1 million/£800,000 = 1.25 This company is finding it harder to pay the interest and would find it difficult to bear any increase in rates Audley Financial Training

  50. Working Capital Current Assets Current Liabilities Working Capital Audley Financial Training

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