University of Portsmouth Personal Finance for Accountants (U13763)

University of Portsmouth Personal Finance for Accountants (U13763) Lecture 5 Investing in Equities

Lecture 5 Investing in Equities • Share Ownership in the UK • Efficient Market Hypothesis • Buying and Selling Shares • Key Investment Indicators • Selecting shares • Tracker Funds

Share Ownership in the UK • The recent survey conducted by the Department of Work and Pensions into the types of savings by UK households in 2004 established that just 22% of households held shares compared with 54% who put their money into banks and building society accounts. So why are households reluctant to invest in shares? • Factors that will influence the choice of investment will be risk, liquidity and taxation.

Share Ownership in the UK • Investing in shares is high risk with a real possibility of losing all of your capital. • This type of investment can not be liquidated easily. If you need cash in a hurry you may have to sell at a loss and there will also be a settlement period. • Unless you are investing within an ISA you will pay tax on your dividends and there is also the potential for capital gains tax when you sell your investment.

Share Ownership in the UK • So why invest in shares? • Over the long term the stock market produces a higher return than other investments around 9% and its also fun.

Determining the Price of Shares. • What determines the price of shares at any given time? • A share price follows the theory of prices that we have learnt in Economics, it is established through the interaction of supply and demand. • In addition the stock market is an example of an efficient market.

Determining the Price of Shares. • Efficient Market Hypothesis (EMH) The EMH implies that all new information is incorporated into a share price rapidly and rationally. The efficient market implies that Share prices rationally reflect all available information and that no trader will be have the opportunity to make an abnormal return, except by chance.

Determining the Price of Shares. • There are different level of efficient markets from weak to strong, the stock market is an example of a semi-strong efficient market. • This means it factors into the price all publicly available information both past and present Including information relating to: • External Economy (National and Global); • Business Sector; and the • Company itself

Buying and Selling Shares • When we invest in the stock market we will buy a quantity of shares, prices can be found in many sources such as the financial press and on the Internet. The price of one British Airways share at currently is 139.6p. This price will continue to move until the market closes each day.

Buying and Selling Shares • There are two prices for each share the buying (offer) and the selling (bid) price. To help you remember its "bid to get rid". • A market maker's bid price is always lower than his offer price which is the price at which he will sell you the security. The difference between the two is known as the 'spread'. Source: http://glossary.global-investor.com

Buying and Selling Shares • Shares are bought through a broker, this is a person who buys and sells securities on behalf of others in return for a commission. • Brokers can be found in high street banks, on the Internet or in a stock broking firm. • When using an on-line broker there is usually a flat fee for a transaction which is typically £12 for one-off trades or £10 for to a more frequent trader. This service is known as ‘execution only’ which means the stockbroker is not offering any advice they are simply carrying out your instructions.

Buying and Selling Shares • These charges makes it uneconomic to buy or sell very small amounts of shares. • The conventional stockbroker will charge a commission on the value of the shares being traded. • Stamp duty is also payable when shares are purchased at 0.5% of the value of the transaction. There is a minimum of £5 for paper-based transactions but no minimum for Internet trading.

Buying and Selling Shares • If we were buying 230 BT shares at a price of 217p using an Internet brokering service the total cost would be as follows: • 230 shares X 217p £499.10 • Other charges: Brokers Commission (flat fee) £12.00 Stamp Duty £499.10 x 0.5% £2.50 • Total cost £513.60

Key Investment IndicatorsExtracted from the FT London Share Service

Key Investment Indicators • The High and Low prices shows the highest and the lowest price for the share over the last 52 weeks. • The Price is the closing price for the share on the day. • +/- is the movement on the closing price compared to the previous days closing price.

Key Investment Indicators • P/E Ratio Current market price per share Earnings per share • The P/E ratio is the number of years it would take to payback the investment. This is a popular method of assessing shares. • A share with a high P/E ratio is one with a high price compared with its recent earnings. This implies that investors are confident about the growth of future earnings. • The P/E ratio is often seen as the barometer of confidence in a company’s prospects.

Key Investment Indicators • Dividend Yield - here the dividend income per share is expressed as a percentage of the price of the share as follows: Dividend (gross up for tax) Current market price per share x 100% • This ratio seeks to assess the cash return on the investment earned by the shareholders. • High figures can suggest higher income from investments, but a high yield can also indicate that a company is not growing very fast or is quite risky.

Selecting Shares • How do we chose a share to invest in? • Investors have a verity of reasons for choosing individual shares to invest in here are some examples: • Existing customer e.g. Marks and Spencer • Investor perks e.g. British Airways holders of 200 shares get 10% off BA air fares. For a full list see: http://www.h-l.co.uk/shares/shareholder_perks/action/list • Low risk strategy e.g. utility companies • High risk strategy e.g. Technology companies • Believe that they can predict the market.

Tracker Funds • Selecting individual shares to invest is a very risky venture. In order to reduce risk it is better to have a well spread portfolio i.e. Shares in different sectors so that if one sector is not doing very well e.g. Telecoms then another sector may be able to compensate for this e.g. Travel and Leisure. • But if you only have a small amount to invest how do you get a diversified portfolio?

Tracker Funds • The answer is to invest in a tracker fund. You purchase a tracker unit trust which mirrors the market. You may for example have a tracker fund which invests in the FTSE all share index. These tracker funds gives you the performance of the index plus any dividends. • There are management fees but they tend to be low on this type of investment (typically between 0.5% - 1% as an annual charge) as they are passively managed.

Investing in Equities • Seminar Work 1. MQC for chapter 11 2. Review questions page 148 of core text. 3. Share cost question attached. • Further Reading Personal Finance and Planning Theory and Practice by Debbie Harrison. Chapter 11 Equities

University of Portsmouth Personal Finance for Accountants (U13763)