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Equity Basics. EQUITY BASICS. AGENDA. DEFINITION CHARACTERISTICS TYPES IN THE BALANCE SHEET RISKS ISSUE OF SHARES DIVIDENDS EXCHANGES ADR ETF. EQUITY BASICS – Definition .
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EQUITY BASICS AGENDA DEFINITION CHARACTERISTICS TYPES IN THE BALANCE SHEET RISKS ISSUE OF SHARES DIVIDENDS EXCHANGES ADR ETF
EQUITY BASICS – Definition An instrument that signifies an ownership position in a corporation, and represents a claim on its proportionate share in the corporation's assets and profits. An equity holder's claim is subordinated to creditor's claims, and the equity holder will only enjoy distributions from earnings after these higher priority claims are satisfied. also called equities or equity securities or corporate stock.
EQUITY BASICS – Definition MORE DEFINITIONS… A stock or any other security representing an ownership interest. On a company's balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as "shareholders' equity". In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage. In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor's portfolio.
EQUITY BASICS – Characteristics Limited liability: The liability of a shareholder is limited to the amount he invested in a company. In case the company goes bankrupt his personal assets can’t be claimed against the losses made by the company. Profit sharing: Investors enjoy unlimited participation in the earnings of the firm. Theoretically there is no limit to the returns, which an equity investor can get. Liquid: Equity stocks are generally highly liquid instruments, which can be bought and sold easily in the equity markets. Ownership stake in the company changes with every buy and sell. An investor can acquire ownership and sell off his ownership quite easily whenever he wishes to do so. Corporate control: Equity stocks come with certain rights including the voting rights to which the investors are entitled.
EQUITY BASICS – Characteristics • Raising capital issuing shares in a company: • Company issues 10 shares each share represents 10% of ownership • Company issues 50 shares each share represents 2% of ownership • Most companies issue millions of shares • In the event of default shareholders are entitled to receive the earnings of the company after: • Wages and salaries • Government taxes • Senior Secured Debt • Second Lien Debt • Convertible Debt • Account Payable • Preferred Equity • Net Profit after Tax are typically split between: • Dividend s • Retained Earnings
EQUITY BASICS – Types • Ordinary Share or Common Stock: • Most common security which represent ownership in a company. Holders of ordinary shares exercise control by electing a board of directors and voting on company policy. Ordinary shareholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation ordinary shareholders have rights to a company's assets only after bond holders, preferred shareholders, and other debt holders have been paid in full. • Preferred Share or Stock: • Class of ownership in a company with a stated dividend that must be paid before dividends to ordinary share holders. Do not usually have voting rights. • Convertible Share or Convertible Preferred Stock: • Preferred share that can be converted into an ordinary share
EQUITY BASICS – On Balance Sheet • DEFINITION OF BALANCE SHEET: • A financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders. • The balance sheet must follow the following formula: • Assets = Liabilities + Shareholders' Equity
EQUITY BASICS – On Balance Sheet • DEFINITION OF SHAREHOLDERS’ EQUITY: • Amount by which a company is financed through common and preferred shares. • Shareholders' equity comes from two main sources: • 1. The original source is the money that was invested in the company, along with any additional investments made thereafter. • 2. The second comes from retained earnings which the company is able to accumulate over time through its operations. In most cases, the retained earnings portion is the largest component.
EQUITY BASICS – On Balance Sheet The Corporation LIABILITIES AND O.E.: + This side represents only claims on the left side + This claims are offered based on a priority order + Claims on cash flows + Claims on residual value • ASSET SIDE: • + Physical part of the firm • + Firms try to generate economic profit • + Strategic planning and asset structure
EQUITY BASICS – On Balance Sheet EQUITY ON THE BALANCE SHEET: + Authorized Shares: total number of shares that the board of directors has agreed and is authorized to sell + Issued Shares: number of shares issued so far + Treasury: shares that have been bought back by the company to return cash to shareholders or improve accounting ratios + Current Outstanding Shares: issued shares minus any Treasury repurchases
EQUITY BASICS – Risk Unpredictability of outcomes: + May not receive any dividends + The price of the shares can fall to zero + But equities have unlimited profit potential + Shares/ Stocks are quoted on public stock exchanges where they can be bought and sold. There is risk from fluctuations in market prices
EQUITY BASICS – Issue of Shares Why issue shares? The issuing company or group receives cash proceeds from the sale, which is then used to fund operations or expand the business. Primary Market vs. Secondary Market Primary markets are those where securities are offered to the public in the form of subscription with the intention of raising money, new issues. Secondary market refers to the market where trading of already existing securities take place.
EQUITY BASICS – Issue of Shares • IPO (Initial Public Offering) • The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded. • No contractual obligation to pay dividend or interest • Never have to repay the principal • Improve accounting ratios on total debt • Cheap financing • FPO (Follow On Public Offer) • Stock issue of supplementary shares made by a company that is already publicly listed and has gone through the IPO process. • Issue more shares to raise funds rather than borrowing • Current shares have their dividends diluted
EQUITY BASICS – Issue of Shares Pre-emption rights Pre-emption rights are the rights of shareholders to be offered any new issue of shares before the shares are offered to non-shareholders. The purpose is to ensure that shareholders have an opportunity to prevent their stake being diluted by new issues. UK & EUROPE Company wants to issue new shares Companies Act Existing shareholders have first refusal US Secondary and Follow-on execution Dilute or non-dilute An offering of shares by shareholders or venture capitalists
EQUITY BASICS – Issue of Shares • Rights Issue • A way in which a company can sell new shares in order to raise capital. Shares are offered to existing shareholders in proportion to their current shareholding, respecting their pre-emption rights. • Current shareholders get the right to lend the company more money (buy more shares) • Usually issued at a discount to make them attractive to shareholders • Preference shares are not subject to pre-emption rights if they are not convertible
EQUITY BASICS – Issue of Shares • Bank equity requirements • World banking regulators, at a meeting in Basel, Switzerland, in mid-September 2010, agreed to raise the amount of common equity required for banks to 4.5% (with a buffer that takes it up to 7% at times) of assets from about 2%. • Basel proposal (the full requirements will not take effect until 2019). • The banking industry argues that increased equity requirements will increase their funding costs because equity is risky and requires a higher return. Forcing banks to use more expensive equity drives up their costs, and these will be passed on to borrowers. They are also concerned with the fact that increased equity requirements would lower the return on equity (ROE) of banks. • Government policies subsidize debt financing and thereby penalize equity financing. Banks prefer debt financing over equity because, by doing so, they lower the amount of taxes they pay and also enjoy the benefits of implicit guarantees by the government.
EQUITY BASICS – Market Capitalization • The total dollar market value of all of a company's outstanding shares.Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. This figure determines a company's size, as opposed to sales or total asset figures. • If a company has 35 million shares outstanding, each with a market value of $100, the company's market capitalization is $3.5 billion (35,000,000 x $100 per share). • Shares outstanding is taken from the most recently filed quarterly or annual report. • Large Cap: $10 billion plus Mid Cap: $2 billion to $10 billion Small Cap: Less than $2 billion
EQUITY BASICS – Stock Split • A corporate action in which a company's existing shares are divided into multiple shares. • Individual share value can increase with a successful company, and the price can become awkward and large. • Stock Splits adjust the number of shares outstanding, for example in a 2-for-1 split, each stockholder receives an additional share for each share he holds. • Overall investor value is unchanged and overall share value is unchanged.
EQUITY BASICS – Dividends • Companies that earn a profit can do one of three things: • 1. pay that profit out to shareholders • 2. reinvest it in the business through expansion • 3. debt reduction or share repurchases or both • When a portion of the profit is paid out to shareholders, the payment is known as a dividend.
EQUITY BASICS – Dividends • The Process • Dividends must be declared (approved) by a company’s Board of Directors each time they are paid. Three important dates to remember regarding dividends are: • Declaration date: The declaration date is the day the Board of Director’s announces their intention to pay a dividend. On this day, the company creates a liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date. • Date of record: This date is also known as “ex-dividend” date. It is the day upon which the stockholders of record are entitled to the upcoming dividend payment. A stock will usually begin trading ex-dividend or ex-rights the fourth business day before the payment date. Only the owners of the shares on or before that date will receive the dividend. If you purchased shares of Coca-Cola after the ex-dividend date, you would not receive its upcoming dividend payment; the investor from whom you purchased your shares would. • Payment date: This is the date the dividend will actually be given to the shareholders of company. • A vast majority of dividends are paid four times a year on a quarterly basis.
EQUITY BASICS – Stock Exchanges Major Stock Exchanges October 2010
EQUITY BASICS – Stock Exchanges • Definition • A stock exchange is an institution or organization that serves as a market for trading financial instruments such as stocks, bonds and their related derivatives. Most modern stock exchanges, like NYSE Euronext, have both a trading floor and an electronic trading system. • Electronic Platforms • Increasing competition for traditional stock exchanges • Reduced cost of entry • BATS Exchange: third-largest exchange in the world by volume behind the New York Stock Exchange and NASDAQ. • The company • Exchange owners and operators are getting themselves listed on their own exchanges and have become private companies. Like NYSE Euronext, Deutsche Boerse AG and the NASDAQ OMX Group, that have evolved into international groups operating on different continents. • Stock exchanges have a vital function in modern economies as places where investors and companies can meet and exchange capitals. They offer standardized instruments which are traded with transparency contrary to what happens in OTC transactions. They display prices and volumes for every products they trade.
EQUITY BASICS – Stock Exchanges • Stock exchanges have multiple functions in the economy: • Raising capital for businesses • The Stock Exchange provide companies with the facility to raise capital for expansion through selling shares to the investing public. • Mobilizing savings for investment • When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in deposits with banks, are mobilized and redirected to promote business activity. • Facilitating company growth • Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion. • Profit sharing • Both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.
EQUITY BASICS – Stock Exchanges • Stock exchanges have multiple functions in the economy: • Corporate governance • By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. • Creating investment opportunities for small investors • As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. • Government capital-raising for development projects • Governments at various levels may decide to borrow money in order to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. • Barometer of the economy • At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.
EQUITY BASICS – ADR • Negotiable certificate issued by a U.S. bank representing a specified number of shares in a foreign stock that is traded on a U.S. exchange. • Shares are held in a depository in the country of origin • Denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. • Enable investors to easily access foreign stock markets • Do not eliminate the currency and economic risks for the underlying shares in another country. • ADRs are listed on either the NYSE, AMEX or Nasdaq.
EQUITY BASICS – Types of ADR • Level I (OTC): Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile. • Level II (listed): more complicated f program for a foreign company. When a foreign company wants to set up a Level 2 program, it must file a registration statement with the US SEC and is under SEC regulation. The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). • Level III (offering): the highest level a foreign company can sponsor. Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies.
EQUITY BASICS – ETF • EXCHANGE TRADED FUNDS: • A security that tracks an index, a commodity or a basket of assets like an indexfund, but trades like a stock on an exchange. • Means of pooling the funds of a large group of investors into a single investment that provides diversified holdings. • By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. • ETFs trade on the stock market and have intraday flexibility to liquidate positions. • They are not actively managed. • Usually sponsored by an investment bank • Trade just like an ordinary stock
EQUITY BASICS – List of ETF’s (1) Equity ETFs 1.1 Broad market ETFs 1.2 Major index-tracking ETFs 1.3 Market sector ETFs 1.3.1 US domestic sectors 1.3.2 Global sectors 1.4 Style ETFs 1.4.1 Large-cap ETFs 1.4.2 Mid-cap ETFs 1.4.3 Small-cap ETFs 1.5 International ETFs 1.5.1 Country ETFs 1.5.2 Regional ETFs 1.5.3 International theme ETFs (2) Commodity ETFs 2.1 Agricultural ETFs 2.2 Energy commodity ETFs 2.3 Industrial commodity ETFs 2.4 Precious metals ETFs (3) Bond ETFs (4) Real estate ETFs (5) Leveraged & short ETFs 5.1 Short ETFs 5.2 Leveraged ETFs 5.3 Leveraged short ETFs
EQUITY BASICS – ETF • ADVANTAGES: • Combine liquidity and tradability of cash stocks with index funds • Create exposure to an index with one simple transaction • Can be created on demand by market makers • Segregated liability between the assets of each fund • Low cost because the ETFs need to keep its Total Expense Ratio low to remain competitive
EQUITY BASICS – How do ETF’s Work? 1. Fund Managers, as authorized participants, choose a market index or basket to mirror 2. Shares of all securities in that particular index or basket are deposited into a holding fund. The mix of shares deposited represents the weighting of such shares in the actual index. 5. To redeem, participants sell ETF shares and receive, from the holding fund, shares of the original component stocks, less fees. 3. Participants are issued an institutional block of the new ETF shares. 4. The ETF shares are traded freely on the open market.
