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Chapter 8: Equity securities: common and preferred shares - Coggle Diagram
Chapter 8: Equity securities: common and preferred shares
Common shares
characteristics
position on asset claims in case of bankruptcy
have a weak position on asset claims
dividends
payable at the discretion of the board of directors
evidence of ownership
shares are most often registered in street certificate form; registered in the name of the securities firm
clearing and settlement
CDS offers computer-based systems to replace certificates
trading units
stocks trade in uniform lot sizes on stock exchanges; the usual unit of trading for most stocks is 100 shares
odd lot/ broken lot: A number of shares which is less than a standard trading unit. Usually refers to a securities trade for less than 100 shares
Historically, an investment in common shares has represented the best investment alternative for long-term capital appreciation. If a young investor intends to invest for the long-term and has the risk tolerance to do so, an investment in common shares is more likely to provide her with long-term capital appreciation.
Benefits and risks of common share ownership
Benefits
potential for capital appreciation
“The right to receive any common share dividends paid by the company”
Voting privileges
“Favourable tax treatment in Canada of dividend income and capital gains”
Marketability
“The right to receive copies of the annual and quarterly reports”
“The right to examine certain company documents”
Risks
“The issuer has no obligation to pay dividends.
• Common shareholders generally have very little influence over the day-to-day operations of the company.
• Common share prices can be volatile, and price changes can lead to investors losing money.
• In terms of claims to assets, common shareholders fall behind creditors, bondholders, and preferred shareholders in the case of bankruptcy or dissolution.”
Capital appreciation
main attraction for many investors
a company's net earnings may be kept as retained earnings and reinvested in the business or distributed to shareholders
many factors can affect a company's stock price
Dividends
regular and extra dividends
a specified amount to be paid each year as a regular dividend
extra dividend: usually at the end of the company's fiscal year; not assume that will be repeated
declaring and claiming dividends
may pay once, twice, or four times a year
an announcement is made in advance of the payment date
shares in the name of the owner: payment cheques are mailed to the owner; if in street certificate form, payments are made to securities firm then credited to the amounts of the firm's clients
ex-dividend and cum dividend
dividend record date: this date are entitled to the declared dividend ( usually 2 to 4 weeks in advance of the payment)
ex-dividend (without dividend) : investors who buy shares during this interval are not entitled to the declared dividend
ex-dividend date is set at one business before the dividend record date; the last day a stock trades cum dividend is the second business day before the dividend record date
e.g. date traded: June 11 ; date settled : June 13 ; dividend record date: June 13 ; this is cum dividend
e.g. date traded: June 12 Thursday ; date settled : June 16 Monday ; dividend record date: June 13 ; this is ex-dividend
dividend reinvestment plans
the company diverts the shareholders' dividends to the purchase of additional shares of the company
reinvested dividend are taxable as cash dividends;
dollar cost averaging: “Participating shareholders acquire a regular, gradually increasing share position in the company at a
reduced average cost per unit
. ”
For example if you buy 100 shares at $10 and another 100 shares at $8, your average cost would be $9 rather than the original $10 you paid when you first started buying shares.
stock dividends
dividends are in the form of additional stock rather than cash
typically paid by rapid growing companies that need to retain a high proportion of earnings
taxable as cash dividend; therefore, many investors prefer to receive cash
Voting privileges
restricted shares (special shares)
do not carry full voting rights
non-voting shares have no voting rights
subordinate voting shares carry a right to vote
restricted shares: subject to restriction on the number or percentage of shares that may be voted by a person, company or group
stock exchange regulations of restricted shares
“Disclosure documents—including information circulars, annual reports, and financial statements sent to voting shareholders—must also be sent to holders of restricted shares, and the documents must describe the restrictions on their voting rights.
• Restricted shares must be identified in the financial press with a code.
• Dealer and advisor literature must properly describe restricted shares.
• Trade confirmations must identify restricted shares.
• Holders of restricted shares must be given notice of shareholders’ meetings. They must also be invited to attend and be permitted to speak at the meetings.
• Minority approval is required for any corporate action that would result in the creation of new restricted shares.”
“Restricted shares must be identified by the appropriate restricted share term.”
Stock splits and consolidations
splits: when the market price of a company's shares is too high, stock splits to reduce the price
consolidation: when the market price is too low (fallen below the exchange's minimum share price rule)
e.g. 3:2 split: 3 shares for every 2 that hold
Reading stock quotations (See book) 8.9
Preferred shares
The preferred shareholder's claim to assets
entitled to a fixed dividend payment
rank behind creditors in their claim to assets, but have priority over common shares in the event of bankruptcy
Pari passu: equally ranking issues of a company's preferred shares
When a company issues more than one class of preferred stock, and those issues are equal in terms of asset and dividend entitlement, the shares are described as ranking pari passu.
Preference as to assets
usually have no claim on earnings beyond the fixed dividend, so the position is ahead of the common shares
Preference as to dividends
dividends are not obligatory; directors can defer the declaration of preferred dividends indefinitely
do not offer the same potential for capital appreciation that common shares provide for investors
interest rate decline, the preferreds would increase (like a bond)
the dividend rate is prime importance to preferred share shareholder
Why companies issue Preference shares
preferred issue versus debt issue
“It is not feasible for the company to market a new debt issue because existing assets are already heavily mortgaged.
• Market conditions are temporarily unreceptive to new debt issues.
• The company has enough short- and long-term debt outstanding (i.e., its debt-to-equity ratio is high). Preferreds would increase the equity component
• The directors are reluctant to assume the legal obligations to pay interest and principal.
• The directors decide that paying preferred dividends will not be onerously expensive.”
preferred shares versus common shares
the stock market may be falling or inactive; business prospects may be uncertain
preferreds avoid the dilution of equity that results from a new issue of common shares (避免股权稀释）
Why investors buy preferred shares
take advantage of the dividend tax credit
the dividends are not taxable in the hands of the receiving company (not the case with debt securities)
Preferred share features
cumulative feature
arrears: “the unpaid dividends accumulate in what is known as arrears. All arrears of cumulative preferred dividends must be paid before common dividends are paid ”
non-cumulative feature
“ Arrears do not accrue, and the preferred shareholder is not entitled to catch-up payments if dividends resume”
callable feature
“can be called or redeemed by the issuer at a stated time and stated price. ”
“Callable preferreds usually provide for payment of a small premium above the amount of per-share asset entitlement fixed by the charter. The premium is compensation to the investor whose shares may be called in. ”
non-callable feature
restrictive; rarely used
voting privileges
“Virtually all preferreds are non-voting, as long as preferred dividends are paid on schedule. However, after a stated number of preferred dividends have been omitted, it is common practice to assign voting privileges to the preferreds.”
purchase fund
if the price of shares declines below market price, the fund will buy specified amounts of the security for redemption;
“Preferreds with a purchase fund have a potential built-in market support ”
sinking fund
“If the shares cannot be purchased in the open market, the issuer is required to call or redeem the securities from investors to ensure that the stipulated amount of securities is retired each year.”
Straight preferred shares
“They provide greater safety than common shares through preference to dividend and asset entitlements.
• For individuals, they provide a tax advantage through the dividend tax credit.
• For corporations, they provide a tax advantage through preferred dividends received from taxable Canadian companies on a tax-exempt basis.
• They provide less safety than a debt investment because dividends are not a legal obligation.”
.
“They do not provide voting privileges (unless a stated number of dividend payments is in arrears).
• They have no maturity date.
• They are less marketable than common shares because there are usually fewer preferreds than common outstanding.
• They have limited potential for price appreciation compared to common shares. The price at which the preferreds could be redeemed by the issuer places a limit on any appreciation that might occur as a result of a decline in interest rates.”
convertible preferred shares
enable the holder to convert the preferreds into some other class of shares at a predetermined price and for a stated period of time
usually sell at a premium above the price; the premium on the preferreds is usually offset by thier higher yield
characteristics
“They provide a two-way security because the holder is in a more secure position than the common shareholder, and yet the holder can realize a capital gain if the market price of the common shares rise sufficiently.
• They usually provide a higher yield than the underlying common shares.
• They provide the right to obtain common shares through conversion without paying a commission.
• They usually provide a lower yield than a comparable straight preferred.
• They sometimes convert into less (or more) than a standard trading unit of common shares, which in turn may be more difficult to sell than a standard trading unit.
• They revert to straight preferreds when the conversion period expires, if conversion has not taken place.”
Retractable preferred shares
shareholder can force the company to buy back retractable preferreds for cash on a specific date at a specific price
soft retractable preferred
redemption value may be paid in cash or in common shares up to the issuer
characteristics
“They provide a two-way security because the holder is in a more secure position than the common shareholder, and yet the holder can realize a capital gain if the market price of the common shares rise sufficiently.
• They usually provide a higher yield than the underlying common shares.
• They provide the right to obtain common shares through conversion without paying a commission.
• They usually provide a lower yield than a comparable straight preferred.
• They sometimes convert into less (or more) than a standard trading unit of common shares, which in turn may be more difficult to sell than a standard trading unit.
• They revert to straight preferreds when the conversion period expires, if conversion has not taken place.”
Floating-rate preferred shares (variable-rate preferred)
interest rates rise, dividend payments increase
are issued in 2 circumstances
a straight preferred is hard to sell and the issuer does not want to make the issue convertible or retractable
the issuer believes that the interest rates will not go much higher than the rate on the new issue date
characteristics
“They provide higher income if interest rates rise, but lower income if interest rates fall.
• They provide a variable amount of annual income that is difficult to predict accurately, but which reflect prevailing interest rate levels.
• As an investment, their market price is less sensitive to changes in interest rates compared to the market prices of straight preferred shares.
The dividend payout of variable-rate preferreds is tied to changes in interest rates on a predetermined basis
.”
delayed floaters / fixed-reset / fixed-floaters
entitle the holder to have a fixed dividend for a predetermined period of time after which the dividend becomes variable
Foreign-pay preferred shares
CAD increases in value compared to foreign currency, the dividend will decrease in value; if the foreign currency increases in value, the dividend will also increase in value
“One of the advantages of this type of preferred share is that, although the dividend is received in a foreign currency, because it is paid by a Canadian company, it is eligible for the dividend tax credit.”
other types of preferred shares
participating preferred shares
“Participating preferreds are shares that have certain rights to a share in the earnings of the company over and above their specified dividend rate.”
deferred preferred shares
do not pay out a regular dividend; on the maturity date, the difference between the purchase price and redemption value is called
dividend premium
the dividend premium is
not eligible for the dividend tax credit
“The advantage of deferred preferreds is that investors can defer taxes paid on income until a later date”
Stock indexes and averages
stock indexes:
“Gauge the overall performance and directional moves in the stock market.
• Enable portfolio managers and other investors to measure their portfolio’s performance against a commonly used yardstick within the stock market.
• Create index mutual funds.
• Serve as underlying interests for options, futures, and exchange-traded funds.”
float 流通股票
“The float refers to common shares issued to the public that are available for trading by investors, and excludes those shares held by company officers, directors, or investors who hold a controlling interest in the company.”
stock average
“the arithmetic average of the current prices of a group of stocks designed to represent the overall market or some part of it.”
the stock average are price-weighted. some prices are higher than others and will have a greater influence on the average as a whole
Canadian market indexes
The S&P/TSX composite index
“measures changes in the market capitalization of the stocks in the index”
the stocks are classified by industry, based on the Global Industry Classification Standard (GICS). This standard was developed jointly by S&P and MSCI (Morgan Stanley Capital International Inc.) for use in all their indexes and is accepted worldwide. ”
some sectors are weighted more: like financials and energy: more than 50%, health care, utilities, and information technology for approximately 5% combined
as indexes move up and down, the percentage change is a more accurate reflection of market performance than net point changes
The S&P/TSX 60 index
60 largest companies that trade on the TSX as measured by market capitalization (市值）
is broken down into 11 sectors that cover all S&P/TSX index subgroup
The S&P/TSX venture composite index
“a Canadian benchmark index for the public venture capital marketplace. Managed by Standard & Poor’s, it is a market capitalization-based index ”
does not have a fixed number of companies
eligible:
“incorporated under Canadian federal, provincial or territorial jurisdictions and represent a relative weight of at least 0.05% of the total index market capitalization.”
must generally be listed on the TSX venture exchange for at least 12 full calendar months as of the effective date of the quarterly revision
U.S stock market indexes
The dow jones industrial average
the most publicity is given to the trading performance of the 30 issues that make up the DJIA
it is price-weighted: when a higher-priced stock rises, it may distort the average
may appear more dramatic than they actually are; tends to underperform the broader market over the long term
The S&P 500 (standard & poor's 500 stock composite index)
is based on a large number of industrial stocks, some financial stocks, some utility stocks, and a small number of transportation stocks
are weighted by their market capitalization
the main gauge for measuring the investment performance of institutional investments in the U.S.
Other U.S. stock market indexes
The NYSE composite index
“a market capitalization index that includes all the listed common equities on the New York Stock Exchange”
NYSE MKT composite index
“This market-weighted index is based on all the stocks listed on the NYSE MKT exchange. The NYSE MKT is a leading exchange for small cap companies.”
The NASDAQ composite index
a market-weighted index of more than 3000 stocks that are traded over the counter;
Its market capitalization is about 30% of the NYSE market capitalization.”
The value line composite index
“about 1,600 stocks that is calculated by taking an average of the daily percentage change in each stock within the index.”
“broadest available barometer of all the U.S. indexes, and includes companies that are listed on the NYSE, NASDAQ, NYSE MKT, and the TSX.”
International market indexes and averages
Nikkei stock exchange
Tokyo stock exchange average
updated every 15 seconds
The FTSE 100 index
100 largest listed companies on London Stock Exchange
use the capitalization of the stock
recalculated on a minute-by-minute basis
The DAX performance index
30 major Frankfurt Exchange blue-chip stocks
most widely followed index on the German securities market
dividends and income are reinvested in the index
The CAC 40 index
40 of the largest 100 companies listed on the Paris Stock Exchange
The Swiss Market Index
blue-chip index; 20 of the largest and most liquid stocks on the Swiss market
common & preferred share
common shareholders: have basically purchased a piece of the company and have claims on all equity items including retained earnings. As profits rise and the company’s prospects look good, common share prices tend to rise as well.
preferred shareholders: do not have the same kind of claim on the company. Preferred shareholders generally receive a fixed dividend and don’t share in any other equity ownership claims on the company other than the par value of their own shares.
while a common stock can soar in price, it's not unusual for a preferred share to move very little or remain, for most part, unchanged.