1. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 1 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter 6 Investors in the Share Market Websites: http://www.ato.gov.au http://www.asx.com.au

2. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 2 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Learning Objectives Appreciate the range of investment choices available for the investor Identify relevant issues for potential investors Understand the factors that influence a company’s share price

3. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 3 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Chapter Organisation 6.1Introduction 6.2Stock Exchange Investment 6.3Buying and Selling Shares 6.4Taxation 6.5Financial Performance Indicators 6.6Pricing of Shares 6.7Stock Market Indices and Published Share Information 6.8Summary

4. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 4 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.1Introduction Recall from previous chapters – Publicly listed corporation – Primary and secondary markets – Ordinary shares have the potential to provide a return to investors by way of dividends and capital gains Depth of the market – The overall capitalisation of corporations listed on the stock exchange (SX)

5. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 5 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.1 Introduction (cont.) Liquidity – The volume of trading relative to the size of the market i.e. turnover Efficient price discovery – The speed and efficiency that new information is reflected in the current share price

6. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 6 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.2 Stock Exchange Investment The SX offers a wide range of security types to the investor Securities listed on the SX are categorised into industry groups allowing investors a choice within a range of economic sectors

7. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 7 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.2 Stock Exchange Investment (cont.) Two types of risk impact on security returns – Systematic risk  Factors that generally impact on shares prices in the market e.g. economic growth, and changes in interest rates and exchange rates – Unsystematic risk  Factors that specifically impact on the share price of a corporation e.g. resignation of the CEO, technology failure, board problems

8. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 8 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.2 Stock Exchange Investment (cont.) Diversified investment portfolio – A portfolio containing a wide range of securities – Diversifies away most of the unsystematic risk of the individual securities  Therefore, investors will not receive higher returns for unnecessarily bearing unsystematic risk

9. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 9 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 62. Stock Exchange Investment (cont.) Diversified investment portfolio (cont.) – The remaining risk is systematic risk which is measured by beta  Beta is a measure of the sensitivity of of the price of an asset relative to the market – Expected portfolio return is the weighted average of expected returns of each share – Portfolio variance (risk) is the correlation of pairs of securities within the portfolio

10. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 10 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.2 Stock Exchange Investment (cont.) Investors may take either an – Active investment approach  Portfolio structure is based on share analysis, new information and risk-return preferences – Passive investment approach  Portfolio structure is based on the replication of a specific share market index e.g. industrial or telecommunications sector index

11. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 11 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.2 Stock Exchange Investment (cont.) Investors need to consider asset allocation within a share portfolio  Risk versus return  Investment time horizon  Income versus capital growth  Domestic and international shares Asset allocation may be  Strategic  Tactical

12. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 12 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.3 Buying and Selling Shares Indirect investment in shares – Investor purchases units in a unit trust or managed fund e.g. equity trust Direct investment in shares – Investor buys and sells shares through a stockbroker  Discount broker i.e. phone and Internet  Full-service advisory broker – Consideration of liquidity, risk, return etc.

13. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 13 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.5 Financial Performance Indicators Potential investors are concerned with the future level of a company’s performance Company’s performance affects both the profitability of the company and the variability of the cash flows

14. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 14 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.5 Financial Performance Indicators (cont.) Indicators of company performance – Capital structure – Liquidity – Debt servicing – Profitability – Share price – Risk

15. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 15 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Capital structure Proportion of company assets (funding) obtained through debt and equity – Usually measured by debt to equity ratio (D/E)  Higher debt levels increase financial risk i.e. firm may not be able to meet interest payments

16. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 16 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Capital structure (cont.) Proportion of company assets (funding) obtained through debt and equity (cont.) – Also measured by proprietorship ratio which is the ratio of shareholder’s funds to total assets  Indicates firm’s longer-term financial viability/stability; and, a higher ratio indicates less reliance on external funding

17. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 17 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Liquidity The ability of a company to meet it’s short- term financial obligations Measured by current ratio – Fails to consider the not very liquid nature of certain current assets i.e. inventory (6.2)

18. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 18 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Liquidity (cont.) Measured by liquid ratio The higher the current and liquid ratios, the better the liquidity position of a firm

19. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 19 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Debt servicing Ability to meet debt-related obligations i.e. interest and repayment of debt Measured by debt to gross cash flow ratio – Indicates number of years of cash flow required to repay firm debt

20. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 20 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Debt servicing (cont.) Measured by interest coverage ratio (6.4)

21. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 21 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Profitability Wide variation in the measurement of profitability – Earnings before interest and tax (EBIT) to total funds ratio – Earnings per share (EPS) (6.5)

22. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 22 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Profitability (cont.) Wide variation in the measurement of profitability (cont.) – EBIT to long-term funds ratio (6.6)

23. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 23 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Profitability (cont.) Wide variation in the measurement of profitability (cont.) – Return on equity (net income/equity) – Higher ratios indicate greater profitability (6.7)

24. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 24 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Share price Represents investors’ view of the present value of future net cash flows of a firm Share price performance indicators – Price to earnings (P/E)  Share price divided by earnings per share  A higher P/E indicates more growth in future net cash flows

25. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 25 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Risk Variability (uncertainty) of the share price Recall, there are two components to risk – Systematic risk (often referred to as beta)  Arises from factors affecting the whole market e.g. state of the domestic economy and world economy

26. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 26 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson Indicators of company performance (cont.) Risk (cont.) Recall, there are two components to risk (cont.) – Non-systematic risk  Arises from firm-specific factors e.g. management competence, labour productivity, financial and operational risks  Can be eliminated in a well-diversified portfolio

27. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 27 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares Share price is mainly a function of supply and demand for a share – Supply and demand are influenced mainly by information – Share price is considered to be the present value of future dividend payments to shareholders – New information that changes investors’ expectations about future dividends will result in a change in the share price

28. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 28 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Estimating the price of a share – General dividend valuation model Where (6.8)

29. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 29 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Estimating the price of a share (cont.) – Valuing a share with a constant dividend – Valuing a share with constant dividend growth (6.9) (6.12)

30. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 30 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Cum-dividend and ex-dividend – Dividends are payments made to shareholders, expressed as cents per share – Dividends are declared at one date and paid at a later specified date – During the period between the two dates, the shares have the future dividend entitlement attached i.e. cum-dividend

31. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 31 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Cum-dividend and ex-dividend (cont.) – Once the dividend is paid the shares are traded ex-dividend – Theoretically the share price will fall on the ex- dividend date by the size of the dividend  Example Share price cum-dividend$1.00 Dividend paid 0.07 Theoretical ex-dividend price 0.93

32. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 32 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Bonus share issues – Where a company has accumulated reserves, it may distribute these to existing shareholders by making a bonus issue of additional shares – As with dividends, there will be a downward adjustment in share price when shares go ex- bonus

33. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 33 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Bonus share issues (cont.) – As no new capital is raised, there is no change in the assets or expected earnings of the company  Example—if a bonus 1:4 issue is made Cum-bonus price $5.00 Market value of 4 cum-bonus shares 20.00 Theoretical value of 5 ex-bonus shares 20.00 Theoretical value of 1 ex-bonus share 4.00

34. Copyright  2003 McGraw-Hill Australia Pty Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Viney Slides prepared by Anthony Stanger 34 Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by Willis Slides prepared by Kaye Watson 6.6 Pricing of Shares (cont.) Share splits – Involves division of the number of shares on issue – Involves no fundamental change in the structure, or asset value of the company – Theoretically the share price will fall in the proportion of the split  Example—5 for 1 split Pre-split share price $50.00 Theoretical ex-split share price $10.00