Chapter 8 Overview of Equity Securities

CHAPTER 8 OVERVIEW OF EQUITY SECURITIES

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EXHIBIT 8-1 COUNTRY AND REGIONAL CONTRIBUTIONS TO GLOBAL GDP AND EQUITY MARKET CAPITALIZATION

(2007)

Source: MacroMavens, IMF World Economic Outlook 2008, Standard & Poor’s BMI Global Index weights.

EXHIBIT 8-2 EQUITY MARKETS RANKED BY TOTAL MARKET CAPITALIZATION AT THE END OF 2008

(BILLIONS OF U.S. DOLLARS)

Rank Name of Market

Total U.S. Dollar Market

Capitalization Total U.S. Dollar Trading Volume

Number of Listed Companies

1 NYSE Euronext (U.S.) $9,208.9 $33,638.9 3,011

2 Tokyo Stock Exchange Group $3,115.8 $5,607.3 2,390

3 NASDAQ OMX $2,396.3 $36,446.5 2,952

4 NYSE Euronext (Europe) $2,101.7 $4,411.2 1,002

5 London Stock Exchange $1,868.2 $6,271.5 3,096

6 Shanghai Stock Exchange $1,425.4 $2,600.2 864

7 Hong Kong Exchanges $1,328.8 $1,629.8 1,261

8 Deutsche Börse $1,110.6 $4,678.8 832

9 TSX Group $1,033.4 $1,716.2 3,841

10 BME Spanish Exchanges $948.4 $2,410.7 3,576

Source: Adapted from the World Federation of Exchanges 2008 Report (see http://www.world-exchanges.org).

EXHIBIT 8-3 REAL RETURNS ON GLOBAL EQUITY SECURITIES, BONDS, AND BILLS DURING 1900-2008

Source: E. Dimson, P. Marsh, and M. Staunton (2009)

EXHIBIT 8-6 INTERNATIONAL COMPARISONS OF STOCK OWNERSHIP IN SELECTED COUNTRIES: 2000–2008

2000 2002 2004 2006 2008 Australia – Direct/Indirect 52% 50% 55% 46% 41% Canada – Shares/Funds 49 46 49 N/A N/A Germany – Shares/Funds 19 18 16 16 14 Hong Kong – Shares 22 20 24 N/A 22 New Zealand 24 N/A 23 26 N/A South Korea – Shares 7 8 8 7 N/A Switzerland – Shares/Funds 34 25 21 21 21 Sweden – Shares 22 23 22 20 18 U.K. – Shares/Funds 26 25 22 20 18 U.S. – Direct/Indirect N/A 50 49 N/A 45

Source: Adapted from the 2008 Australian Share Ownership Study conducted by the Australian Securities Exchange (see http://www.asx.com.au). For Australia and the United States, the data pertain to direct and indirect ownership in equity markets; for other countries, the data pertain to direct ownership in shares and share funds. Data not available in specific years are shown as “N/A.”

COMMON SHAREHOLDERS

• Share in the operating performance of the company.

Ownership interests

• Claim on assets after all liabilities have been paid.

Residual claimants

• Voting rights on major corporate decisions.

Governance participants

VOTING RIGHTS

Voting rights

Statutory voting

Cumulative voting

Share classes

Vote by proxy

EMBEDDED OPTIONS

Callable common shares Putable common

shares

PREFERENCE SHARES (PREFERRED STOCK)

Generally do not have voting rights

DIVIDENDS ON PREFERENCE SHARES

Cumulative Noncumulative

Participating Nonparticipating

POSSIBLE ADVANTAGES OF CONVERTIBLE PREFERENCE SHARES

Earn a higher dividend

Opportunity to share in profits

Benefit from a rise in the price of the common shares

Price is less volatile than the common share price

PRIVATE EQUITY SECURITIESEquity securities

Private

Venture capital

Leveraged buyouts

Private investment in public equity

Public

INVESTING IN NONDOMESTIC EQUITY SECURITIES

Direct investment

•Buy and sell shares directly in foreign markets.

Depository receipts

(DR)

•Global depository receipts (GDR)•American depository receipts (ADR)•Global registered share (GRS)•Basket of listed depository receipts (BLDR)

EXHIBIT 8-16 SUMMARY OF THE MAIN FEATURES OF AMERICAN DEPOSITORY RECEIPTS

Level I (Unlisted)

Level II (Listed)

Level III (Listed)

Rule 144A (Unlisted)

Objectives Develop and broaden U.S. investor base with existing shares

Develop and broaden U.S. investor base with existing shares

Develop and broaden U.S. investor base with existing/new shares

Access qualified institutional buyers (QIBs)

Raising capital on U.S. markets?

No No Yes, through public offerings

Yes, through private placements to QIBs

SEC registration Form F-6 Form F-6 Forms F-1 and F-6

None

Trading Over the counter (OTC)

NYSE, NASDAQ, or AMEX

NYSE, NASDAQ, or AMEX

Private offerings, resales, and trading through automated linkages such as PORTAL

Listing fees Low High High Low Size and earnings requirements

None Yes Yes None

Source: Adapted from Boubakri, Cosset, and Samet (2008): Table 1.

RETURN CHARACTERISTICS OF EQUITY SECURITIES

Dividend incomePrice change (capital gain)

Foreign exchange gains or losses

Reinvested dividends

EXHIBIT 8-17 IMPACT OF REINVESTED DIVIDENDS ON CUMULATIVE REAL RETURNS IN THE U.S. EQUITY MARKET: 1900–2008

Source: Dimson, Marsh, and Staunton (2009).

METHODS FOR ESTIMATING RISK AND RETURN

Historical data•Average rate of return•Standard deviation

Probability distribution of possible returns•Expected return•Standard deviation

PREFERENCE SHARES ARE LESS RISKY THAN COMMON SHARES

Less risk

Known liquidation

value

Priority claim on income

Fixed dividend

EMBEDDED OPTIONS AND RISK

Higher risk:• Callable• Nonputable• Noncumulative

Lower risk:• Noncallable • Putable• Cumulative

WHY ISSUE EQUITY?

Raise capital

Finance revenue-generating activities

Ensure going concern status

Increase liquidity

Mergers and acquisitions

Stock-based compensation

GOALS FOR MANAGING EQUITY

Increase book value

Maximize market value

• Increase net income• Retain more earnings• Issue shares

• Manage investors’ expectations

ACCOUNTING RETURN ON EQUITY (ROE)

Financial Year Ending31 Dec 2008 31 Dec 2007 31 Dec 2006

PfizerNet income $8,104,000 $8,144,000 $19,337,000Total stockholders’ equity $57,556,000 $65,010,000 $71,358,000

%2.132/)000,010,65$000,556,57($

000,104,8$ROE

%9.112/)000,358,71$000,010,65($

000,144,8$ROE

2/BVEBVENIROE

2008

2007

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MARKET VALUE, BOOK VALUE, AND PRICE-TO-BOOK RATIO

Pfizer Market price $16.97 Total shares outstanding 6,750,000 Total shareholders’ equity $57,556,000 Total market value of equity $114,547,500

Market value of equity = Market price per share × Shares outstandingMarket value of equity = US$16.97 × 6,750,000 = US$114,547,500

Book value of equity per share = Total shareholders’ equity/Shares outstandingBook value of equity per share = US$57,556,000/6,750,000 = US$8.53

Price-to-book ratio = Market price per share/Book value of equity per sharePrice-to-book ratio = US$16.97/US$8.53 = 1.99

THE COST OF EQUITY

Company wants to raise equity capital

Company not contractually obligated to shareholders

What is the cost of equity?

INVESTOR’S REQUIRED RATE OF RETURN

Investor’s minimum required rate of return

Cost of equity

Estimate with pricing models: dividend discount model (DDM),

capital asset pricing model (CAPM), etc.

SUMMARY

• Types of equity securities• Importance and relative performance of equity securities• Ownership characteristics and voting rights• Investing in nondomestic equities• Risk and return characteristics• Market value and book value• Cost of equity, (accounting) return on equity, and investor’s

required return