CHAPTER 7

EQUITY
SECURITIES
MARKET
Presented by
Jonel Dominic Raymundo
Kyla Palaña
Allana Marie Mier
Julia Ross A. Reyes
 Equity Instruments
Is a type of financial instrument wherein the issuer agrees to pay
an amount to the investor in the future based on the future
earnings of the company, if any, like shares.
 Authorized Shares
It is the maximum number of shares that a corporation may
issue stated in the Articles of Incorporation.
 Outstanding Shares
Refers to the total shares of stock issued under the binding
subscription agreements to subscribers or stockholders,
whether partially or fully paid.
 Three Major Forms of Businesses
Organizations in the Philippines
Sole Proprietorship
A type of business with no distinct personality and is owned by an individual who has
unlimited liability for any debts and obligations of the business.
Partnership
Formed when two or more persons bind themselves to contribute money, property or
industry to a common fund with the intention of dividing the profits among
themselves.
Corporation
An artificial being created by operation of law, having the right of succession and
powers, attributes and properties expressly authorized by law or incident to its
existence.
Why Invest in Equity Instruments?
Capital Appreciation
Refer to the rise in the value of an asset in relation to the increase in its
market price which can be volatile.
Dividends
These are payments made by corporations to shareholders representing
excess earnings of the company of the company. They may take the form
of cash, property, notes or other evidence showing corporate
indebtedness, or own shares of the company.
Improper Accumulated Earnings Tax (IAET)
It is a penalty tax imposed on corporations who
intend to accumulate excess earnings to enable
it's shareholders to avoid paying 10% final tax on
dividends on dividends that they might have
received if these were declared. An IAET of 10%
is imposed on the improperly accumulated
earnings if the corporations are found to be
guilty of improperly accumulating earnings.
 Comparison between Debt vs Equity
DEBT EQUITY
They have the legal right to receive They only have expectations of
payment on the amount that they being repaid in the future which
invested or lent out. makes it riskier.

They have no voice in the They have a voice in the

management of the business. management of the business.

They have a higher priority in They have a lower priority in

claims on assets and income over claims on assets and income over
equity. equity.
 Comparison between Debt vs Equity

DEBT EQUITY
It is a temporary type of financing. It is a permanent type of financing.

It has a maturity date for when the It has no maturity date although it
company needs to repay the debt. can be sold to a second market.

It has a lower risk relative to equity It has a higher risk relative to equity
because of inherent contractual because of uncertain returns and
obligation. fluctuating market price in second
markets.
 Comparison between Debt vs Equity

DEBT
The returns are only up to contractual
interest which is a lower return
expectation than in equity.
Can be used as a tax deductible
expense by the issuing company.
EQUITY
The returns may increase without
limit as long as the business is
successful which is a higher return
expectations compared to debt.
Cannot be used as a tax deductible
expense by the issuing company.
Types of Shares
 Preference Shares
Gives it's holders distinct rights that enable them to be
prioritized over ordinary shares. A fixed periodic dividend,
whether percentage or peso amount, is promised to it's
holders of preference shares making it's share prices usually
stable. Normally it's holders don't have voting rights, but the
corporation can opt to give them voting rights explicitly
stated in the Articles of Incorporation.
 Preference Shares
It's treated as quasi-debts, the required dividend associated
with preference shares is like interest on the debt but without
a maturity date, which must be settled first before any claims
can be claimed by ordinary shareholders, usually costing the
company a lot more than issuing debt. When issued, an
agreement is made which contains relevant information such
as it's par value, amount of dividend, date of payment and
other restrictive covenants such as omitting of payment of
dividends, minimum liquidity requirements, mergers and
acquisitions, sale of assets and repurchases of ordinary
shares.
 Preference Shares
When issued, an agreement is made which
contains relevant information such as it's par value,
amount of dividend, date of payment and other
restrictive covenants such as omitting of payment
of dividends, minimum liquidity requirements,
mergers and acquisitions, sale of assets and
repurchases of ordinary shares.
 Types Preference Shares
Cumulative Preference Shares
Entitles the holders of the receipt of previous year's unpaid
dividends or dividends in arrears before any payment can be
made to ordinary shareholders upon dividend declaration.

Participating Preference Shares

Entitles the holders of the receipt of additional dividends after
holders of both preference and ordinary shares have been paid
up to the current year's dividends.
 Types Preference Shares
Redeemable Preference Shares
Entitles the issuing corporation the option to call or redeem the
outstanding shares at a certain call price within a predetermined
period of time.

Convertible Preference Shares

Entitles the holders of the option to exchange the shares for
some other securities of the issuing corporation after a certain
date, usually ordinary shares.
 Ordinary Shares
Represents true owners or residual owners in the corporation but
only having limited liability. They carry the greatest risk, gaining
earnings only after satisfying the creditors and preference
shareholders claims; however they also ordinarily share in
earning to the greatest extent if the corporation is successful.
 Ordinary Shares can be
Privately Owned: Owned by private investors and shares are generally
not publicly traded.

Closely Owned: Owned by an individual investor or a small group of

private investors like a family.

Publicly Owned or Publicly Traded: Owned by a mix of public and private

investors and shares are actively traded in stock markets.

Widely Owned: Owned by many unrelated individual or institutional

parties.
 Ordinary Shares
They possess voting rights to decide on certain corporate
decisions and preemptive right to retain their proportionate
ownership in the firm in case of issuance of new shares
preventing dilution of ownership.
 Companies give stock rights to the shareholders to excrcise
preemptive rights. Stock Rights is a financial instrument which
permits shareholders to buy additional shares from the company
at a price cheaper than market price, in direct proportion to the
number of shares they own. Each ordinary share grants one vote
that can be assigned and casted directly by the shareholder or
indirectly by transferring their votes to another shareholder in
shareholder meetings.
Other Types of Ordinary Shares
Supervoting Shares: Shares that have multiple votes associated
with one share.

Nonvoting Ordinary Shares: Shares that have no voting rights.

 Stock Market
It's composed of exchanges over the counters where the shares
are issued and traded publicly. It is both physical and virtual, and
can be considered both a primary and secondary market.

Stock Exchange
These are the physical sites where shares are purchased and
sold face-to-face on a trading floor like the New York Stock
Exchange.
Modes to Trade Stocks
 Organized Exchanges
Is an auction market employing Floor Traders that oversee and
facilitate the trading specific shares.The Floor Traders are
representatives of different brokerage firms who meet at the
trading post on the exchange and gather the current bid and ask
prices. The Floor Traders match buy and sell orders from their
clients in around 90% of trades, while the remaining 10%, the
floor traders buy the shares for themselves or sell shares from
their inventory.
 Over-the-counter Market
It refers to the market wherein shares can be traded by Dealers
that are connected electronically by computers. Dealers try to
"make a market" by matching the buy and sell orders they receive
from investors and are very important it it's success. Dealers are
usually responsible for the bid and ask prices. Dealers earn
through two means: through the spread between bid price and
ask price and through commissions on trades.
 Electronic Communications
Network
It's a network which directly links major brokerage firms and traders and
removes the need for a middleman. It is Transparent because traders
can easily view if there are unfilled orders timely. It Reduces Cost
because it removes the middleman and commission. It allows Faster
Execution because trades are matched faster and confirmed quicker
since it is fully automated. It allows After-hours Trading because trading
can continue at any time of the day due to its availability. It can only
work well with shares that have a substantial amount of trading volume.
 Exchange-traded Funds
It happens when a portfolio containing various securities is
purchased and a share is created based on this specific portfolio
which can be traded in the exchange. They are often indexed,
listed and can be traded as individual shares in the exchange,
valued based on the underlying net asset value of the shares
inside the index portfolio, have transparent information about the
shares inside are publicly available, do not have minimum
investment amount, lower management fee and are preferable
since they can be traded like a normal share. However they are
subject to commission to brokers when they are being traded.
Largest Stock Markets in the World
1. New York Stock Exchange
2. Tokyo SE Group
3. NASDAQ QMX
4. NYSE Euronext (Europe)
5. London Stock Exchange
6. Shanghai Stock Exchange
7. Hong Kong Exchanges
8. TSX Group (Canada)
9. BME Spanish Exchanges
10. BM & FBOVESPA
 Stock Market Indexes
It measures the overall performance of a stock market, which
represents the average of stock prices currently being traded.
The value is usually set at 100 in a base year. It intends to show
the movement of price over time. An increase of more than 20%
in stock prices is usually called a bull market or bullish, on the
other hand on decline of more than 20% in stock prices is usually
called a bear market or bearish. Investors use this to gain some
insight on how a group of stocks could have performed in the
market.
Economist believe that changes in stock prices affect
economy since it affects spending households and
businesses
Impacts of Changes in Stock Prices
A. Large Corporations: They treat the stock market as an
essential fund source for expansion projects.
B. Macro Level: Share account for significant portion of
household wealth.
C. Consumers and Businesses: Fluctuations of market prices
affect their expectations.
PHILIPPINE
STOCK
EXCHANGE
Philippine Stock Exchange (PSE)

the national and sole stock exchange in the Philippines and one of the oldest stock
exchanges in Asia located at the PSE Tower in BGC, Taguig.
was created in 1992 due to a merge of the two former stock exchanges:
(1) The Manila Stock Exchange
(2) The Makati Stock Exchange
composed of 15 man board of directors headed by Jose T. Pardo as chairman
received a “self-regulatory organization” or SRO status from the SEC (meaning it can
implement its own rules and set penalties on erring trade participants and listed
companies).
regulates trading activities trough Capital Markets Integrity Corporation (CMIC)
CMIC
– has the authority to investigate and resolve trading related irregularities and
unusual trading activities involving issuers based on complaints received,
findings and reports. It also oversees the market through a world-class and
sophisticated surveillance system called Total Market Surveillance (TMS).

TMS
– developed by the Korea Exchange and is designed to safeguard the integrity of
the stock market fraud, manipulation, and breaches of the marketplace rules of
erring market players.
Other Initiatives to safeguard interests
of the investors:

Enforcement of static and dynamic thresholds to

protect against unusual share price fluctuations

Disclosure requirement for publicly listed

companies

Securities Investors Protection Fund, Inc. or SIPF

 Companies who plan to list publicly in PSE
should:
1. Comply with the laws, regulations and full disclosure rules and policies of the Philippine
Government.
2. Have standards of quality, operations, and size under efficient and effective management.
3. Conduct issuance, offering the marketing of securities in a fair and orderly manner and
ensure that securities are widely and equitably distributed to the public.
4. Give adequate, fair and accurate information about the company and its securities to the
general public to enable them to make informed investment decision.
5. Ensure that directors and officers act in the interest of all security holders as a whole,
particularly where the public represents only a minority of the security holders or where a
director or security holders owning a substantial amount of shares has a material interest in
a transaction entered into by the company.
General Criteria for Admission to listing
in the PSE:
a. Track record of profitable operations

b. Exceptions to the 3-year track record requirement

c. Positive Stockholders’ equity

d. Market Capitalization

e. Operating history

f. Minimum capital requirement

g. Minimum offering to the Public

h. Minimum number of stockholders

i. Valuation of assets
j. Full payment of issued and outstanding shares

k. Investors relation program

Company Information
Company news
Financial reports
Disclosures
Investors FAQ’s
Investors contact
Stock Information

A company that incurs negative stockholders’ equity for 3 consecutive year shall be
subject to delisting, in accordance with the rules of the exchange.
 DISCLOSURE RULES

All companies listed in the PSE are required to comply

with its disclosure rules. The basic principle of the exchange is to ensure
full, fair, timely and accurate disclosure of material information from all
listed companies.
 Classification of Corporate Disclosure:
1. Structured Continuing Disclosure
– reportorial requirements submitted within specific time frames
such as annual, quarterly, and monthly reports. This includes:
Annual report (SEC Form 17-A)
Three Quarterly Reports (SEC Form 17—Q)
Reports on beneficial Ownership
Other periodical reports to update and keep current
information on the operation of the business and financial
condition of the company
2. Unstructured Continuing Disclosure
– communications of corporate developments as they happen and are
intended to update the investing public on activities, operations and business
of the company.

Objective: for the company to update the investing public with any
material fact or event that occurs which would reasonably be expected to
affect investors’ decision in relation to the trading of its securities.
 Disclosures must be made promptly by the issuing company if it
meets any of the following:
a. Where the information is necessary to enable the company and the public to
appraise their position or standing, such as, but not limited to, those relating
to the company’s financial condition, prospect, development projects
contracts entered into in the ordinary course of business or otherwise, merger
and acquisitions, dealings with employees, suppliers, customers and others,
as well as information concerning a significant change in ownership of the
issuer’s securities owned by insiders or those representing control of the
issuer; or
b. Where such information is necessary to avoid the creation of a false market
for its securities
c. Where such information mar reasonably be expected to materially affect
market activity and the price of its securities
 Some of the events that prompt disclosure if required from listed
companies:

Change in the control of the company

Filing of legal proceeding against the company involving a claim amounting to 10 %
company’s assets
Change in corporate purpose and material alterations in company’s activities or operations
Resignation or removal of directors, officers or senior management and their
replacements and the reasons for such
Any delay in the payment of debentures, negotiable obligations, bonds or any other
publicly traded security
Losses or potential losses, the aggregate of which amounts to at least ten percent of the
consolidated total assets of the company
Dissolution
Contracts of any nature that might limit the distribution of profits
 ·
Fines of more than 50,000.00 and/or other penalties on the company or on its
subsidiaries by regulatory authorities and the reasons
Merger, consolidation or spin-off of the company
Modification in the rights of the holders of any class of securities issued by the
company and the corresponding effect of such modification upon the rights of the
holders
Declaration of cash dividend, stock dividend and pre-emptive rights by the board of
directors
Any change in the company’s fiscal year and the reason(s) behind
All resolutions, approving material acts or transactions, taken up in meeting of the
board of directors and stockholders of the company

Corresponding penalties are meted to listed companies that fail to comply with
the disclosure requirements of PSE.
PLATFORMS FOR CAPITAL
MARKET
Conventional Brokerage
Investors buy or sell shares by opening an account with a
stockbroker.

The broker will buy and sell shares in behalf of the investor in
exchange for payment called commission.

Brokers can provide sound investment advice to their client-

investors on what stock trading decision to take.
Online Trading
Involves the trading of securities through an online platform.

Online brokers typically charge lower commission

compared to conventional brokers.

Online brokers do not offer any investment advice and other

services that a traditional broker can give.
Mutual Funds
Mutual funds are an investment company that pools money
from various investors and invests them to a different
securities based on the investment objective of the fund.

Mutual funds allow investors to diversify their portfolio since

mutual funds hold shares in different companies.
 MARKET CAPITALIZATION
Refers to the total market value of all outstanding shares of a
company.
Calculated by multiplying the total outstanding shares by the
prevailing market price per share.
Important dictator used by investors to determine the size of the
company.
Allows investors to benchmark the relative size of a company
against another.
Reflects how much investors are willing to pay for the shares.
 Factor That May Impact
the Market Capitalization of a Company
Significant changes in the share value - whether higher or lower -
could impact market capitalization, same with changes in the
number of shares issued. Any exercise of warrants will increase
the number of outstanding shares, thereby diluting its existing
value .
 SHARE VALUATION
Defined as the technique for calculating the estimated value of
companies and their stock, with a specific end goal to foresee
moves in the market and resulting share costs.
Share valuation techniques are commonly grounded in identifying
how much cash flow can be received in the future if the investor
purchases the share now.
The value of a share is equivalent to the present value of the future
cash flows that can be received from an investment. (Discounted
cash flow approach)
 ONE-PERIOD OR MULTIPLE PERIOD
VALUATION MODEL
Individual investors do not plan to buy shares to take over control in
firm; they leave the management and board of directors to do their
work.
Instead, investors look at share purchases to receive a greater return.

If the investor intends to sell the share after a fixed number of years,
he/she only needs to consider the dividend he/she expects to receive
during the time he/she holds the shares.
For this type of investment wherein there is an expected fixed
holding time, it is helpful to use the formula below.

Where

The required return represents the discount rate which investors expect
to receive in exchange for assuming risk in an investment.
DIVIDEND-BASED VALUATION TECHNIQUES
• The most common share valuation technique is through dividends

Where
The basic dividend-based valuation model can be further
interpreted by anticipating how much dividend will grow in the
future.

There are 3 models that can be used; zero-growth model, constant

growth and variable growth.
ZERO-GROWTH MODEL

The zero-growth model assume that the dividend will be fixed and
not change anymore in the future. This is the simplest approach to
share valuation.

Zero-growth model is very useful in valuing preferred shares since

the dividend is already fixed upon issuance.
The Formula for zero-growth model is:

Where

The equation above shows that a zero-growth model assumes that the present
value of the share equates to the present value of perpetuity of the expected
dividend discounted at the required return.
CONSTANT-GROWTH MODEL

The constant growth model or the Gordon growth model

(named after Myron Gordon) is the most widely known model
used in share valuation.

The constant growth model operates under the following

assumptions:
a. Dividends are assumed to grow at a constant rate forever (or at an extended period
of time). This will yield reasonable results since errors regarding far-off cash flows are too
small to be discounted to the present.

b. Growth rate is always assumed to be lower than the required return. This is a reasonable
assumption since if growth rates were higher than the required return the firm may grow
impossibly large in the long run.

c. The first dividend is assumed to be received right away and the next dividend will be
received after a year.

d. Reasonableness of expectations of investors regarding future profitability of the firm and

future dividends is important to determine right share valuation.
The constant growth model formula is shown below:

Where
VARIABLE GROWTH RATE

An inherent limitation associated with the zero-growth and

constant growth model is it does not allow flexibility in terms of
growth rate expectations.

Since future growth rates may go up or down as a result of

changes in economic conditions, a variable growth model was
developed to incorporate changes in growth rate in the valuation.
There are four steps involved in the variable growth model:

1. Determine value of expected cash dividends at the end of each year using the initial growth rate
assumption/s. To compute for this, apply the growth rate assumption on the current dividend and
do this year on year.

2. Compute for the present value of the expected dividends during the initial growth period.

3. At the end of the initial growth period determine the value of the stock (from that point to
infinity) using the constant growth model. The assumption here is that from this point onwards,
dividend will grow at a constant pace, hence, the use of the constant growth model.

4. Lastly, add the computed present value of the expected dividends during the initial growth
period and the computed value of the stock at the end of the initial growth period.
Other Approaches
to Share Valuation
Free Cash Flow
Alternative in using dividend-based share valuation
techniques
Cash flow refers to the available for debt creditors and
shareholders
It follows the same premise as the dividend-based valuation
techniques
computes the present value for future cash flows that are
expected to be received by the company
 The Free Cash Flow Valuation Model
estimates the value of the entire company as a whole

Market Value of Entire Company

- Market Value of Debt
- Market Value of Preference Shares
__________________________
Value of Ordinary Shares
Book Value per Share
Refers to the amount per share that will be received if all of the
company's assets are sold based on its exact book or
accounting values and whose proceeds will go to ordinary
shareholders after claims from creditors and preference
shareholders.

*This method does not consider expected earnings potential of the firm and does not
have any link or relationship to the true value of the firm in the market
 Book Value of Assets - Book Value of Liabilities
Book Value
per Share
= __________________________
- Book Value of Preference Shares

Total No. of Outstanding Shares

Liquidation Value per Share
Actual amount per share that will be received if all assets are
sold based on their current market value and all liabilities
(including preferred shares) are fully paid and the proceeds are
divided between the remaining shareholders.
It is more realistic than the book value
Price Earnings (P/E) Multiples
Uses the price-earnings ratio to compute for the share price
The Price/Earnings ratio shows the amount that investors are
willing to pay for each peso of earnings
The P/E multiples is a very popular approach in estimating
how much the shares of a firm are value
The P/E multiples is treated as a better methodology
compared to book value per share and liquidation value share
The P/E multiples is computed by multiplying
the expected EPS of the company by the
average P/E ratio for the industry where the
company is similar.
A high than average P/E ratio may mean two
things:
Market is expecting company earnings to increase in the future
which will pull down P/E to the normal level or
Market feels that company earnings has low risk and investors
are willing to pay premium for them
Limitations of Share Valuation
Changes in Expected Dividends
Changes in Risks/Required Return
Problems with Growth Estimations
Problems with Risk Estimations
Problems with DIvidend Forecasting
 Market Efficiency
Setting of share prices in the market through the
interactions of buyers & sellers
 Efficient Market Hypothesis
developed by John Muth
describes the behavior of a perfect market

1. Securities are typically equilibrium, which means that they are fairly priced
and that their expected returns equal their required returns
2. At any point in time, security prices fully reflect all information available
about the firm and its securities, and these prices react swiftly to new
information
3. Because stocks are fully paid and fairly priced, investors need not waste
their time trying to find mispriced (undervalued or overvalued) securities
 Hybrid & Derivative Securities

Hybrid Securities Derivative Securities

financial instruments that are securities that are not debt

carry characteristics of both
debt and equity instruments
Examples: Stock Warrants,
Convertible bonds, Convertible
Preference Shares
nor equity but derives its value
on an underlying asset which
is another security
Citation
H. C. Baron, Cachero, A. L., & Lascano, M. V. (19). Equity Securities
Market. In (Ed.), Fundamentals of Financial Markets (pp. 171-202).
Philippines.
Baysa, G. J., & Lupisan, M. C. (2018). Accounting for
partnership and corporation. Mandaluyong City: Millennium Books.