Understanding and using accounts for wealth research

1. Understanding and using accounts for wealth research Christopher Murphy Ravensbourne Research Limited

2. Topics • Business vehicles • Types of share • Options • Valuing businesses • Data sources

4. Limited liability • many businesses (and nearly all those of much size) have limited liability • their owners stand to lose only their investment in the business if things go wrong • so their personal assets are safe from creditors

7. Limited companies • denoted by word ‘Limited’ or ‘Ltd’ in their name • warns other parties that the owner’s liability is limited to their investment in the firm • potential creditors thus know that the owner’s personal assets cannot be seized if the company doesn’t pay what it owes

8. Limited by guarantee • over 90,000 companies have no share capital • the liability of their owners (‘members’) - ‘guarantors' as opposed to ‘shareholders’ -is limited by guarantee • a popular legal form for charities, educational bodies

9. Limited by shares • far more common (well over 2 million of them) • liability of the members – ‘shareholders’ – is limited to the nominal value of their shares • nominal (‘face’ or ‘par’) value of shares is very different from their market value • shares with nominal value 10 pence each, currently being traded on stock market at 643 pence

11. Limited Liability Partnership • LLP form available since 2001 • limited liability for non-negligent partners • but not for those judged negligent • has proved very popular (over 40,000) • treated like companies for filing purposes, thus have to file accounts

12. LLP ‘Designated Members’ • there must be at least two • they are responsible for company secretary type duties • all members may be designated members

13. Limited companies

14. Public and private companies • public companies may offer shares to public • ‘Public Limited Company’ or ‘PLC’ • private companies may not • tighter rules apply to PLCs

15. Exemptions from disclosure based on company size • size of PLCs irrelevant - no exemptions • nor for large private companies • medium and small companies get disclosure exemptions - if they choose to claim them

17. Disclosure requirements for small companies • must file a balance sheet • need not file • profit and loss account • directors’ report (though these are usually filed voluntarily)

18. Definition of a small company • meets at least two out of three conditions • turnover (sales) doesn’t exceed £5.6 million • balance sheet total (i.e. either total assets or total liabilities) doesn’t exceed £3.26 million • average number of employees doesn’t exceed 50

20. Bad news for researchers • full accounts filed by just 1 in 8 actively trading companies

22. Listed plcs • only PLCs may join London Stock Exchange • thus becoming a ‘listed company’ • however most Plcs are not listed • only about 2,000 out of 8,300

23. Quoted companies • ‘listed’ and ‘quoted’ used virtually synonymously, but a distinction can be made • companies may choose to be quoted on markets other than the London Stock Exchange, e.g. • PLUS Markets Group (formerly Ofex) quotes share prices for over 100 UK companies • NASDAQ OMX • while not listed their shares are ‘quoted’ and more data is available

24. Business vehicles • Types of share • Options • Valuing businesses • Data sources

25. Ordinaryshares most common type also called ‘equity’ shares usually carry voting rights last in queue for dividends Preference shares don’t have voting rights pay a fixed dividend preference share dividends paid before ordinary ones Types of share

26. Other types of preference share • cumulative preference share - get missed dividends from earlier years • participating preference shares - get extra dividends in very good years • redeemable preference shares

27. Convertible preference shares • ‘convertibles’ • can be converted into equity shares

28. Rewards from shareholding • shares are safer, but upside probably limited • equity shares more risky, potentially more rewarding • convertibles offer a two-way bet

29. Nominal v beneficial owners • nominal owners are those listed in public records like Annual Returns • used by large portfolios for administrative convenience • and to conceal real owners’ identity

30. Business vehicles • Types of share • Options • Valuing businesses • Data sources

31. Options • rights granted to directors to buy a certain number of shares at a set price within a limited period • idea is to align individual performance with company’s fortunes • when actual share price exceeds exercise price scope for director making a profit

32. But • usually conditional • ‘forfeited options’ – lost by director leaving or failing to meet performance targets • sometimes they lapse before end of exercise period

33. Option terminology • ‘vesting’ – delay between award of option and them being exercisable • ‘partial vesting’ – vested in stages • ‘cliff’ – no shares vested in first period • ‘submerged’ options – exercise price below option price • ‘deemed’ – director doesn’t actually own individually (pension scheme)

34. Business vehicles • Types of share • Options • Valuing businesses • Data sources

35. Many valuation techniques • Market Capitalisation (market cap) • Earnings and Dividend payout multiples (PER & DPS) • Total Shareholder Returns (TSR) • Net Asset Value (NAV) • Discounted Cash Flow (DCF) • acquisition prices paid for comparable companies (comps) • sectoral ‘rules of thumb’ • EV/EBITDA

36. Even for quoted companies valuation is a judgement, not a purely objective science

37. Price earnings ratio • probably most common ratio used • relates the earnings (profits) a company delivers to the share price (the price for those earnings)

38. Definition of PER • current share price divided by earnings per share • i.e. £5/25 pence= PER of 20 • jargon –’PE’,’20 times earnings’,’multiple of 20’

39. Private companies • even more difficult • no share price quotations to help us • traditional discount of a private company’s value compared with a quoted one

40. PER for private companies • ‘earnings’ are post-tax profits • ‘price’ is what a comparable company is sold for

41. BDO • Private Company Price Index (PCPI) measures trends in prices • www.bdo.co.uk/library

43. But differences in PERs • private company discount usually higher for smaller companies • PERs vary between sectors • best to look at closest comparators

44. ‘Bottom line’ • ‘earnings attributable to equity shareholders’ • could all be paid out (‘distributed’) to the shareholders as dividends • but management often ‘retain’ (reinvest in the business) part or all of the profit

45. Earnings Per Share (EPS) • Earnings attributable to ordinary shareholders • divided by number of issued ordinary shares

46. Dividends • depends on size of ‘earnings attributable to ordinary shareholders’ • and dividend policy chosen by board • measured by ‘Dividends Per Share’ (DPS) • individual dividend pay-outs determined by DPS multiplied by number of shares they hold

47. Business vehicles • Types of share • Options • Valuing • Data sources

48. Shareholders • individual holdings shown in ‘Annual Return’ • but may be hidden behind nominees • no mechanism for identifying beneficial owners in private companies

50. Directors’ report • shows holdings by individual directors • in quoted companies lists all shareholders holding over 3% of total voting share capital