DOBLE TITULACIÓN

A D E / Derecho –Year 2

E Q U I T Y M A RK ET S

LECTURER:
NICK SMITH

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 INDEX
• Equity Markets
• What is Equity? 3

• Historical Perspective 4

• How EquityWorks? 10

• The Stock Exchange 13

• Structure of the Spanish Stock Exchange 21

• Trading and Operations 29

• IPO’s 57

• Stock Market Indexes 63

• Takeovers 72

• Equity MarketsToday 74

• Equity Investors 81

• EquityAnalysis 86

• Conclusions 111

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 Equity – Definition

EQUITY = OWNERSHIP

“EQUITY represents partial ownership in a company,

and as an equity owner you share the risks and
rewards of a company’s business.”

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 Equity - Historical Perspective

Debt has been with us for thousands of years….

– Campaign and war debt /bonds
– Commercial debt
– Trade finance
– Lending against future crop harvests
– Documented evidence of money-lending from 2000 BC across Assyria
and Egypt

But Equity only starts to appear from 1500’s….why the change to the
financing model?

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T he world suddenly got bigger…

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 Equity for financing exploration

Financing of a trade exploration Average success rate in 16th ...but returning ship (two or three
trip by grouping ships in joint Century exploration was less than years later) could have 10,000%
stock company. 25%... returnon investment.

Would you “LEND” money with no visibility, long maturity and high
risk? Makes more sense to demand “EQUITY” ownership, as it is high
risk but almost limitless upside.
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 Equity – Historical Perspective

• Better way of financing exploration, but eventually adopted as model for

all types of capital-intensive investment.
• Centred around Antwerp, Bruges, London in the early years.
• First official exchange, generally agreed to be Amsterdam after the Dutch
East India Company (VOC Vereenigde Oost-Indische Compagnie) sold
public shares in 1602.
• Markets lacked structure and regulation, with fraud commonplace.
• Selling of shares in non-existent projects and companies, even a case of a
“company for carrying out an undertaking of great advantage, but nobody
to know what it is”
• 1720, the collapse of the South Sea Bubble showed the need for a
regulated market place
• But it wasn’t until 1792 that we had properly regulated trading…

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Equity – Historical Perspective

The Buttonwood Tree at 68 Wall Street, site of the signing of the

first formal securities’ trading agreement on May 17th 1792.

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 Equity - Historical Perspective

• The Buttonwood Agreement, led to the first “modern” exchange in

New York.
• Share trading was restricted to licensed brokers, with just 24 members
at formation.
• Generally agreed commission rate of 0.25% per trade, which lasted
nearly 200 years.
• Model was copied in most major cities.

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 Equity - Introduction

Equity Shareholders acquire RIGHTS, when buying shares:

– The right to VOTE on company strategy

– The right to RECEIVE A DIVIDEND (share of companyprofit)
– The right of TRANSMISSION (shares may be sold to someone else)
– The right of SUBSCRIPTION if new shares are issued

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 Equity - Introduction
EQUITY for the SHAREHOLDERS

RISKS:
✓ Company failure and bankruptcy. All bank debt, company bonds,
corporate loans, pension liabilities (and a long list of etc) are ahead of
Equity to be paid in company liquidation. If the company fails you are
likely to lose everything.
✓ Volatility. Shares may never reflect real value of a business. You may
be right but the MARKET sets the value, and the market may remain
wrong longer than you can remain solvent.

REWARDS:
✓ The upside for Equity holders is literally unlimited, and capital
appreciation can be many thousands of time your initial investment.

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 Equity - Introduction

EQUITY for the ISSUERS

A D VANTAGES:
✓ It’s cheap. No dividend, no cost.
✓ It’s for ever. No payback, no redemption date.

DISADVANTAGES:
✓ It could lose you your company…Takeovers.
✓ It’s dilutive. You must share future profits.
✓ It’s transparent. Shareholders & Public will know
everything about your company.

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THE STOCK EX C H A N G E

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 Equity Markets
The Equity Markets are the central market places
for the exchange and transmission of share
ownership .They (are supposed to) provide:

- Efficiency

- Regulation

-Vigilance

- Accessibility

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 The Equity Market
The meeting place for demand and supply of capital

Demand for Capital

✓ New share issues (IPO’s), or sale of additional shares to raise capital.

✓ Market facilitates replacing the need for debt with the use of Equity.

Supply of Capital
✓ Savings and investments not destined to other asset classes.
✓ Allows surplus capital (savings) to be reallocated to more economically
productive uses (company investment).

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 The Equity Market
An institution for the channeling of investment

✓ Provides a regulated market place, governed bylaw.

✓ Provides investor protection (as far as posible) via
supervision of information and reporting.
✓ Provides a liquid market place for capital allocation,
allowing greater price setting efficiency via the
correct balance between supply and demand
✓ Provides a broad market for capital access allowing
investors to invest in assets that would otherwise be
unavailable.

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Case Study:
The need for regulation and vigilance

✓Founded by Jenaro Garcia in 1999 to provide

bandwidth and wifi services.
✓IPO in Madrid in 2010 with an initial value of €36mn.
✓The company’s value rose to over €1.4 bn over the
next four years, as investors bought into this tech
company bringing wifi to the streets
✓In 2014 one research hedge fund (Gotham Research in
New York) published a report saying that the company
was a fraud.
✓Income was overstated, accounts invented, data on
usage was inaccurate and most of what company
claimed was false.
✓Not one investor until that day had checked the
published data.
✓After halving on the market, the shares were
suspended and written down to zero as part of the
bankruptcy process.
✓Lesson: Do your homework and don’t rely on others to
do it for you….

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 The Equity Market
Exchange Structures vary, but all are built around three main
pillars:

✓ REGULATOR – Usually State owned andsupervised

✓ MANAGER /OPERATOR – Normally private

✓ SETTLEMENT /CLEARING HOUSE – Private and often

subsidiary of the manager, or bank sponsored

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 The Equity Market
The Regulator (SEC, FCA,CNMV)
✓ Supervision and vigilance of the Stock Market
✓ Ensure transparency of information and correct price
formation

✓ Investor protection
✓ Ensure all relevant legislation is adhered to
✓ Verification that all securities meet requirements to allow
them to trade on the Exchange
✓ Control the process of takeovers
✓ Register and make public all relevant price sensitive
information
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 The Equity Market

The Manager/Operator (NYSE, NASDAQ, BME, EURONEXT)

✓ Management of the electronic trading platform. Exchanges
now are basically IT companies.
✓ Responsibility for publication of trading data and
maintenance of market data base

✓ Assures smooth running of daily trading activity

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 The Equity Market
The Clearing House (Euroclear, LCH,Iberclear)
✓ Vital role of management of the settlement and clearing process of Stock
Exchange operations, matching share ownership changes with cash
movements.
✓ Payment against delivery. The exchange of share ownership is simultaneous
to the exchange of cash.
✓ Precise settlement calendar. Trading settled two days after execution (T+2).
Blockchain will allow instant settlement in the future.
✓ Guaranteed delivery. The Clearing House must assure that buyers and
sellers receive shares / cash in a timely manner. To this purpose stock
lending is used to avoid failed trades. Penalties for non-delivery.

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 Spanish
“Bolsa deValores”

REGULATOR: CNMV, COMISION NACIONAL MERCADO DE VALORES

MANAGER: SOCIEDADES RECTORAS DE LAS BOLSAS

OPERATOR: BME (OWNED BY SIX - SWISS EXCHANGE)

SETTLEMENT: SCLV IBERCLEAR

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 Spanish
“Bolsa deValores”

REGULATOR: CNMV, COMISION NACIONAL MERCADO DE VALORES

Depends on Ministry of Economy and President is a

political appointment

Stated targets:
• Transparency of markets
• Correct price formation
• Protection of Investors
• Control and publish all relative information
• Monitor both issuing companies, as well as Members
of the Exchange (Brokers)

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 Spanish
“Bolsa deValores”
MANAGER: SOCIEDADES RECTORAS DE LAS BOLSAS

Specific Functions:
• Authorize listing of shares after CNMV approval
• Suspend listing of shares in certain circumstances
• Publish all information related to share trading, volumes etc

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 Spanish
“Bolsa deValores”
OPERATOR: BME (OWNED BY SIX - SWISS EXCHANGE)

• BME (Bolsas y Mercados Espanoles)

• Previously owned by the Members (brokers), and was then listed on the
Exchange as a private company
• Bought in a takeover (OPA) by SIX Swiss Exchange in 2020
• System operator of the SIBE (Sistema de Interconexión Bursátil Español),
the local trading platform
• Now faces competition from alternative international Exchanges…Chi-X,
BATS,Turquoise

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 Spanish
“Bolsa deValores”

SETTLEMENT: SCLV IBERCLEAR

SCLV Iberclear
(Servicio de Compensación y Liquidación de Valores)

• The settlement and clearing company of the Exchange, owned by BME

• Its role is the management of the settlement and clearing process of
Stock Exchange operations, matching share ownership changes with cash
movements.

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 The Equity Market

Trading takes place on:

• Primary Market: Initial Public Offerings (IPO’s) and capital raises

from listed companies

• Secondary Markets: Trading of previously listed shares

• BME Growth (originally Mercado Alternativo Bursátil MAB):

Small company listing

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 Equity Brokers

Sociedades y Agencias de Valores y Bolsa.

• Brokerage companies that must adhere to activities governed by Stock

Market Law (Article 71 of the Ley del Mercado de Valores LMV).

• Important demarcation with Institutional Investment companies. SVB’s

may not manage investment money directly, nor participate in Investment
Management companies.

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 Equity Brokers

Sociedades y Agencias de Valores yBolsa.

• Sociedades de Valores y Bolsa (SVB) require a minimum capital base of

€2mn, and may trade for third parties or on their own account.

• Agencias de Valores y Bolsa (AVB) require a minimum capital base of

€0.5mn, and may trade only for third parties.

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Equity Trading,
from this…

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Equity Trading,
to this…

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 Equity Trading
• “Open Outcry Trading” The original, historic method of trading was
present from the founding of the Bolsa de Madrid in 1831 until 2009. 10
minutes sessions where buyers and sellers would shout out bid and offer
positions until individual agreements (Hecho!) were reached

• Still exists in limited markets, such as CBOT and CME commodity

options (Chicago)

• But Equity trading now nearly 100% electronic via SIBE and equivalent
systems

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 Equity Trading
So how does it work in practice?
✓ Markets are mainly “order-driven”…the supply and demand set the
price.
✓ Specific stocks and markets still maintain “quote-driven”…a trader
sets the price.
✓ It is an open and semi-transparent market place, based around a
rolling auction model.
✓ PRICE PRIORITY: best priced orders (highest buys, lowest sales)
have priority in the order book.
✓ TIMING PRIORITY:When prices are the same, the earlier an order is
entered into the order book the higher position it will occupy.
✓ Market orders will always be executed against the best available price
on the other side.
✓ Curbs exist to limit volatility and avoid stampedes in both directions.
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Equity Trading…live screen

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 Equity Trading

Different phases of daily trading

1. Pre-Opening and opening auction

• 30 minute pre-opening period (8.30 – 9.00). Orders to buy and sell may
be entered into the system until the official opening where the
equilibrium point of supply and demand is reached ie. Where the
greatest volume of buyers and sellers are in agreement. New orders may
not be entered during calculation period. The end of this “auction” has a
aleatory end that may vary by up to 30 seconds to avoid price
manipulation.
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 Equity Trading

Different phases of daily trading

2. OpeningAuction

• After matching of auction orders at equilibrium price, unmatched orders

remain in the system and form basis of open session order book. The
market is now open and further orders may enter.

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 Equity Trading

Different phases of daily trading

3. Open Market.

• Between 9.00 and 17.30 (11.30 – 17.30 for the LatIbex) the market is
open and orders may be entered, modified or cancelled. When buying
and selling orders coincide at a determined price the system matches the
orders and a trade occurs. Price is the first determining factor in the
oredr queue, followed by timing if prices are the same.

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 Equity Trading

Different phases of daily trading.

3. Open Market.

• The order book is “semi-transparent”. All participants can see orders in

the system but not who is buying or selling. Additionally, brokers may
hide the full quantity of interest, only revealing it as the order is
progressively filled.

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 Equity Trading

Different phases of daily trading.

4. Market Close and ClosingAuction

• Between 17.30 and 17.35 there is an additional closing auction which

follows the same rules as the pre-opening. The resultant price of the
closing auction is the closing price for each individual stock that day.

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 Equity Trading

Different phases of daily trading

4. Market Close and ClosingAuction

• The closing auction was established in 2000 to provide a fairer closing

price fixing mechanism.

• If less than 500 shares trade on closing auction, the closing price of a
stock will be the price traded that is closest to the weighted average of
the last 500 shares traded in that session. If less than 500 shares trade in
a day,the closing price remains that of the previous day.
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 Equity Trading

Different phases of daily trading

5. Fixing system for less liquid stocks

• To avoid a long session with little activity, smaller companies use the
fixing system that just uses two auctions:
• First auction: At 12.00 although orders can go into the book from
8.30

• Second auction:At 16.00, with orders counting from close of first

auction.The second auction price is used as the stock close for
the day.The minimum volume for closing price setting in the
fixing market is 200 shares.

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 Equity Trading

Different phases of daily trading

6. Block Market

• This parallel market allows the crossing of especially large volume blocks
of stock “Put-throughs”, subject to minimumvolumes:
• All stocks that trade on the S.I.B.E. can be traded in this system as well.
Trading hours for this system are from 9:00am to 5:30pm.

• Minimum volumes range from €15,000 for illiquid stocks to €650,000 for
the most liquid, with a sliding scale in between.

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 Equity Trading

Different phases of daily trading

7. Special Operations Market

• Also known as the “After Hours market”, this exists so brokerscan

register special transactions, such as changes of ownership or new
shares being issued.
• Transactions here must fulfil certain cash and price requirements.The
special operations market is open from 5:40pm to 8:00pm.

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Equity Trading

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 Equity Trading

1. Basic order types

• Market orders: are orders entered without a specific price limit and
which are traded at the best opposite-side price at the time of entry. If
the order is not fully executed against the first opposite-side order, it will
continue to be executed at as many opposite-side prices as are necessary
until it is completed.
• In case of being in an auction, the order will remain positioned to the
best price respecting the time priority of orders.
• These orders can be introduced both in auctions and on the open
market.
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 Equity Trading

2. Basic Order types

• Market to limit orders: are orders without a price which are limited to
the best opposite-side price on the order book. If the share is on the
open market and there is no order on the opposite side of the order
book, the order is rejected.

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 Equity Trading
3. Basic order types
• Limit orders: are orders to be executed at their limit price or better.
Buy orders are executed at this price or at a lower price on the opposite
side of the order book. Sell orders are executed at the limit price or at a
higher price on the opposite side of the order book.

• These orders allow:

- The wish to trade up to/ from a certain price to be expressed.
- The execution of an order against existing market orders at a
price no lower than the limit price with the rest being left on the market at
the limit price.
• These orders can be entered both on the open market and during
auctions.
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 Equity Trading

4. Conditional Orders

• The following conditions may be applied to market orders:

➢ Immediate or Cancel: W ill cancel any balance after the highest
possible amount has been matched at price

➢ Minimum volume: Systems rejects an order if a minimumdetermined

by the broker is not matched.
➢ Fill or Kill (All or Nothing): Must be fully matched or will be rejected
by the system

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 Equity Trading

5. Hidden (Iceberg) Orders

• Large in Scale orders (LIS) may hide part of their volume to avoid adverse
market reactions
• The order appears in multiples of the visible amount after completion of
each tranche.
• Each newly visible tranche only maintains price priority but its timing
priority is reset to the time it becomes visible.
• Hidden orders may not be used in fixing system.

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 Equity Trading

How hidden orders work in practice:

After market purchase of 300 shares, the hidden balance moves to the back
of the queue

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 Equity Trading
6. Midpoint Orders

• Orders may be inputted that automatically adjust to the

midpoint of the order book

• If the market is showing best bid @ 1.40 and best offer @

1.50, the order will set to 1.45

• Minimum execution quantity at the midpoint may also be

defined

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 Equity Trading
7. VWAP Orders

• Volume Weighted Average Price can be agreed upon to cross

a block ofstock

• Price is not known by the two counterparties until the

period closes (often the full day).

• Brokers must then communicate the transaction to the

Exchange within 15 minutes of market close.

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 Equity Trading

Validity of orders according to market phase:

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 Equity Trading

Order validity periods:

- Valid for one session.Will be cancelled before next trading day.

- Valid to a specified date.Will be cancelled on close of that date.

- Good until cancelled (GTC). Valid for a maximum of 90 days after which
they must renewed.

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 Equity Trading
Volatility Auctions:A five minute trading halt and new auction may be
triggered by excessive volatility. Shares assigned a static range based on
normal volatility, if price crosses EITHER direction there is an auction

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 Equity Trading
Volatility Auctions: Shares also assigned a dynamic range, set on normal
market volatility, referring to how much a share price can move from one
price to another. Designed to halt price manipulation and wrong ticks.

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 Equity Trading

Additional concepts:

- Market Making – Brokers may “make prices” for potential blocks of

shares and then execute on their own risk.Also known as “risk pricing”.

- Liquidity Providers – Companies may have liquidity contracts with

brokers to ensure there is always minimum volume in their company.

Broker bids and offers stock in the company’s name with strict controls.

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 Equity Listing
IPO (Initial Public Offering)
Public sale of shares in a company
Sale of existing shares, sale of new shares (to raise fresh capital) or a
combination of the two

Timing and phases:

✓ Communication to Regulator and registry of the prospectus
✓ Management Roadshow to explain the business to investors
✓ Indications of demand
✓ Price fixing
✓ Allocation of shares and likely pro-rata in function of demand
✓ Shares start trading
✓ Payment and settlement of IPO shares
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 Equity Listing
IPO Participants:
✓ Global Co-ordinator. Controlling bank /broker that sets

supply and gauges demand. Responsible for price fixing and

distribution of shares.

✓ Managers & Co-Managers; Banks /brokers that organize

marketing and sell the shares to their clients. Selected on
corporate relationship and client types /geographies.

✓ Underwriters:Will guarantee (for a fee) the success of the

transaction by promising a minimum income to issuing

shareholder. Will buy any unsold shares directly.

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 Equity Trading
Secondary Market Offerings & Rights’ Issues:

✓ Issue of new shares by a listed company by a similar process to IPO.

✓ Shares typically discounted to atttract demand and used to raise
funds for new investment.
✓ Exisiting shareholders receive preferential rights to buy new shares
and these rights may be traded separately.
✓ Often done as ABB (Accelerated Book Build), as an after-market
auction of new shares. Banks will normally underwrite part or all of
the transaction.

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 Equity Trading
Stock Splits
✓ Management may decide on a “Split” when the share value has
risen so much as to make an individual share easier to buy. This
makes N O difference to the value of the company as share price
should adjust by same multiple as the split.
✓ The inverse is a Contra-split, where shares in issue are reduced in
the same way.This can happen when the share price has fallen to a
very low number, especially after issuing large numbers of new
shares (“dilution”).Again, there is N O change in total value of the
company.

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 Equity Trading
Dividends /Buybacks
✓ The two ways that companies can “pay” their shareholders.
✓ The Dividend is the part of a company’s profit that management decides to
give out proportionally among all shareholders
✓ Two days before payment, shares trade EX the right to receive the dividend
and the share price adjusts down the equivalent amount.

✓ Dividend payment is completely discretional and subject to management

policy, and it may be paid in cash or in new “bonus” shares in the company
✓ A buyback is also considered part of shareholder remuneration, as
company uses excess cash to buy shares and cancel them. It supports the
share price and adds to the proportional amount of the company you own.

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 Equity Trading
Short Selling
– Designed to allow investors to make money when share prices
decline not rise.

– Custodian banks “lend” shares to investors, principally hedge funds for

a rental fee.
– Shares can then be sold in the market, with the hope that share price
will decline and can be bought back cheaper.

– Short seller makes (or loses) on price difference between sale and
repurchase. Borrowed shares are then returned.

– Necessary tool of liquid markets or evil tool of speculation?

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 Equity Indexes
Index Definition

• An indicator of equity market activity, both for the

broad economy (country /regional level) and for
determined sub-sectors (tech stocks, banks…)

• Used for derivative contracts, trackers and ETF’s

• Key factor is for an index to show
diversification, as it is the average activity of a
group of component companies.

• Bias to upside caused by continued re-selection of

“winners”.

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 Equity Indexes
Dow Jones Industrials since 1900 – the use of a Logarithmic scale

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 Equity Indexes
SP500 versus SP500 total return index – the power of the dividend

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 Equity Indexes
Company index weightings are
Free Float Weighting
limited depending on free
float…
FF <=10% 10%
✓ Floating Capital =
Shares open to free 10%< FF <=20% 20%
market transactions
✓ Captive Capital = 20%< FF <=30% 40%
Direct “permanent”
holdings of greater than 30%< FF <=40% 60%
5% of the company and
shares owned by Board
Members 40%< FF <=50% 80%

50%< FF 100%

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 Equity Indexes
When diversification fails…

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 Equity Indexes

SPAIN:The IBEX 35

• IBEX 35 is the official index in Spain, composed of the 35 mostliquid

companies

• Formed in December 1989 (as the FIEX-35) with base 3000

• First real time index as Indice General de la Bolsa de Madrid used

closing prices.

• Used as base for expanding futures and options markets that need a
market reference.
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 Equity Indexes

Ibex-35: Calculation

• Use Market Capitalization of each component (share price

multiplied by shares issues gives “market value”)

• Adjust for “free float factor”. Companies may have shareholdings that
never trade and they are discounted.

• Telefonica has close to 100% free float, but Inditex less than 50%....

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 Equity Indexes

Ibex-35: Calculation

• Once free float factors applied the resulting “adjusted” market

capitalization of the IBEX 35 can be calculated form second to second

 CAP(IBEX − 35t )
IBEX − 35t = IBEX − 35 t−1  FACTOR(J)
CAP(IBEX − 35 t−1 )

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 Equity Indexes

IBEX family of Indexes

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 Equity Trading
Takeover bids:
– An offer directed to all shareholders by a potential purchasor to buy some
or all shares in a company, with the purpose of reaching a significant position
in the ownership of a company. Normally triggered at 30% ownership.

– This may be friendly (with support of management) or hostile (against

management wishes).

– May be cash, shares of mixture of both.

– The process may be contested, with various parties bidding at the same time.
Management may search for a “White Knight” to counter a hostile approach,
or even try to bid for company making the approach “Pacman defence”.

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 Case Study:
How a takeover can get complicated…
✓ Sep 2005 Endesa trades at around €18. Gas Natural bids €21.30 (€7.45
in cash). Iberdrola to buy excess assets and La Caixa to finance.

✓ Seen as challenge to Madrid from autonomous communities, aided by

PM Zapatero need for regional support. Endesa rejects and PP
condemns, opening major political issue.

✓ Feb 2006 counter bid by German company Eon at €27.5. Government

imposes conditions against EU free market rules and European
Commission intervenes.
✓ Nov 2006 Acciona buys 10% in “dawn raid” and takes stake to 25% in
subsequent market purchases at €32.
✓ EON raises bid three times to €40, but Acciona sides with ENEL and bids
€41.
✓ March 2007 EON abandons bid in return for favourable asset purchases.
✓ April 2007 €41.3 final bid and Acciona / Enel consortium buys 92%.

✓ September 2007 Acciona sells their share to Enel in exchange for

Endesa renewable business. Coincides with start of the financial crisis, so
not fully approved until April 2009.

✓ Three and a half years….politics, shareholder pacts, multiple bidders,

absurd premium. Only winners? Endesa shareholders, Acciona and a lot
of lawyers.
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 Equity Markets Today
✓ Algorithmic Tradingdominates
daily equity volumes.
✓Electronic trading not just a
result of technological
improvements, but also
investment styles as passive
investing and ETF’s have grown
in importance.
✓HFT (High Frequency Trading)is
most mentioned, but relative
volumes now stable.
✓All institutional investors now
trade via Algo, taking out the
human element

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 Algo Trading

Advantages
✓ Speed of execution. Premium on latency….speed to market,including
physical distance to Exchange computers.
✓ No human error. Able to process millions of data points and instructions
every second.

✓ Cheaper! Plug and play systems remove need for monitoring and oversight.

Disadvantages

✓ Machine capacity to spot unusual occurences is limited

✓ Create momentum waves that can become “flash crashes” or “flash rallies”.

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Algo types:
Algo Trading
– Execution only: Guarantee average prices over a period, such asVWAP
(Volume Weighted Average Price). Divergence trades, pair trades and
contingent conditions.

– Momentum trading: Computers taught to recognize volume /Price events and

“front run” genuine client orders.
– Trade Strategies: looking for patterns, correlations and tipping point events.
Easy to spot historic trade flags but what guarantees they will always be
repeated? False correlations common.

– Arbitrage: between different platforms, trading price discrepancies.

– Machine learning is the future of Algo trading. Can computers be trained to
learn from mistakes? Need for continuous innovation to avoid everyone
processing the same information.
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 Equity Trading
Alternative trading platforms:
– Last ten years marked by proliferation of MTF’s (Multilateral Trading
Facilities, such as BATS)….alternative venues to trade, with lower cost and
different liquidity measures.

– Dark Pools (Liquidnet, Posit) allow clients to trade blocks with no

market visibility at lower cost.

– Total volume remains the same but investors now going where they want for
liquidity and/or price, rather than monopoly of incumbent Exchanges.

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 Equity Trading
So where can Broker /Dealers still add value?
– Need to rely on added value trading services, such as “risk pricing”.
How to make a market in a large block of stock (+€50mn)and
assume the risk yourself.
– Calculate volatility, need to hedge position even temporarily,
estimate “slippage” (effect on price of buying or selling), set price to
be competitive but try to assure profit.

– Still a very valid trading role but high risk, and basically just using
bank capital to buy business.

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 Equity Trading
Regulation
✓ MIFID II final blow to broker profitability.
✓ “Unbundling” of services such as research and execution, so everyone must
disclose how much they pay for what services.
✓Commission pot today maybe 10% of what it was 15 years ago, while
compliance costs rise.
✓ Result? Less companies covered, less analysts, less efficient markets and more
price distortion at the margin?

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 Equity Brokerage
PRIMARY SECONDARY

(CORPORATE FACING) (INVESTOR FACING)

EXECUTIO N RESEARCH
Operating for Paying for advice
A D VISORY commission

M&A ECM SALES

Mergers and
Equity
Capital
& SALES
Acquisitions Markets TRA D IN G

C O RPORATE PROPRIETARY
BROKER DEALING TRADING
Liquidity contracts and Physical Execution
share buybacks

EQUITY MARKETS

EXCHANGES, DARK POOLS, MTF’s

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 Equity Investors
So who owns all the Equity?

81
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 Equity Investors
And more and more is passive …following indexes and not actively managed

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 Equity Investor Styles

PASSIVE ACTIVE

ABSOLUTE RELATIVE
TRACKERS
RETURN RETURN

LONG/SHORT,
GLOBAL
ETF’s MARKET VALUE GROWTH
MACRO
NEUTRAL

EVENT DRIVEN,
ALPHA YIELD GARP
RISK
CAPTURE
ARBITRAGE

RELATIVE THEMATIC
CTA STAT ARB Eg ESG
VALUE

MULTI ASSET SHORT BIAS ACTIVIST

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Equity Investors
Value versus Growth

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 Case Study:
Why hedge funds exist…
✓ Alfred Winslow Jones created the first HEDGED (not hedge) fund in
1949, inventing the concept of MARKET NEUTRALITY. Fund not
affected by direction of the market but by relative performance of
individual investments.

✓ Also invented the leveraged capital model and performance fee

remuneration. Over 34 years of managing the fund Jones only had three
losing years.
✓ By the late sixties, there were many imitators, notably George Soros
and Michael Steinhardt.
✓ Today’s hedge funds have many different strategies, but the model is
remarkably similar. The wealth generation for partners is without parallel
in any corner of the financial markets.

✓ Their reputation remains “clouded”. Companies are private therefore

not very transparent, and they are often portrayed as speculators and
vultures. No one mentions Soros without saying he was the man who
broke the Bank of England, with attack on Sterling in the ERM.
✓ Is this justified? Hedge funds bring liquidity, activism, price discipline.
They expose fraud and stop corporate abuse. They are the ultimate
capitalist vehicle that a capitalist system needs.
✓ Voluntary Reading: “More Money Than God: Hedge Funds and the Making of a 85
New Elite”, by SebastianMallaby
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Equity Analysis

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 Equity Analysis
Equity Research: the fundamental analysis of a company and prediction of
future stock market returns…

✓ Aims to define fair value of companies that share prices should tend
towards. Not a market timingindicator.

✓ Identifies “Intrinsic” value to compare with “market” value.

✓ Medium /long term view, based on future expectations for the company.

✓ Formed via knowledge of the industry, understanding of company’s

financials and ability to model what company will look like in 3 to 5 years.

“Share Price is the Net Present Value of Future Expectations”

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 Equity Analysis
Value and Price need not coincide, as there is no single definition of
value:

✓ Investors may have different expectations for the future of a

company
✓ Investors may associate different values to company characteristics
✓ Investors may have different interests regarding the future of the
company
✓ Investors all have different time horizons

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 Equity Analysis
Valuation can use many tools, but all share need for accurate analysis of how
the company will perform in the future.
• Future Sales – New products, large contracts, activity of a
competitor, consumer demand, the economy and how it affects
demand for products or services?

• Future profit – Cost control, need to increase/decrease

workforce, need to invest and need to expand?
• Management Expertise – Ability to react to changes andinnovate?
Ability to control the business and avoid errors?
• Future dividends – How much of future earnings will the
investors see?

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 Equity Analysis
Static Methods Dynamic methods

– Estimate the stand alone – Focus on future value

value of a business : – Value a business in function of

capacity to generate earnings in
• Accounting Value
the future
• Asset value
• Discounted Dividends
• Liquidation value
– Not necessarily forward • Discounted Cash Flows

looking • EVA (Economic Value Added)

measuring return against cost
– Doesn’t account for the time
of Capital employed
value of money

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 Equity Analysis
Multiples: The most common Multiples:
– Requires analysis of a – P/E – Price/Earnings – How much profit
company’s future prospects, is generated for each share divided by its
but… value. Most common but flawed.

– ….uses this information to – EV/EBITDA – Enterprise Value/Earnings

compare the company to Before Interest Taxation Depreciation
similar businesses or past Amortization. More technically correct,
cycles as accounts for debt.

– Based on the theory that – Dividend Yield – The return paid by the
markets tend towards company to shareholders divided by the
efficiency price paid for a share.

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 Equity Analysis
TOP DOWN:
From global factors to more company specific:
Global economy
National economy
Sector analysis
Market shares
Barriers to entry
Profitability
Strategic management
Financial management
Operating performance

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 Equity Analysis

• MACRO is key to understanding broader market moves.Equity

markets move more on “top down” than “bottomup”.

• But the economy has huge effect on a company’s prospects

• Interest rates, inflation,ecomonic growth,currency movements,

changes in taxation, changes in economic policy

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 Equity Analysis

• Interest Rates - the cost of money

• Rates rising improves the “opportunity cost” for holding monetary
assets….bad for the Equity Market?

• Rates rising indicates a strong economy….good for companyearnings

and the Equity Market?

• Equilibrium growth and rates is the key

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 Equity Analysis
BOTTOM UP:
Company analysis

Sectorial analysis

Macro factors

Intrinsic Value versus MarketValue

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 Technical Analysis
• The study of historic price charts to predict future price movements
• Ignores fundamental value of companies and just tries to spot repeated
moves

• Based on “herd mentality” of investors….looking for trends,

resistances, supports, panic and complacency……

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 Technical Analysis
• The only time it really works? When sentiment shifts and the market is
either too positive or too negative….

• Relative Rotation of Sectors

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 EQUITY VALUATION

FUNDAMENTAL TECHNICAL

MACRO MICRO SENTIMENT,

MOMENTUM,
PSYCH O LOGY
TOP-D O W N BOTTOM -UP
INVESTING INVESTING

STATIC DYNAMIC
EC O N OM IC
CYCLES
ASSET VALUE, FUTURE VALUE C O M PARABLES STATISTICAL
INTEREST
LIQUIDATION &
RATES
REPLACEMENT
C O N SUMER DCF P/E C O RRELATION
SUM OF THE
SPENDING DIV. DISCOUNT EV/EBITDA BIG DATA
PARTS (SOTP)
EVA DIV. YIELD BLACK BO X
POLITICS (ROCE/WACC) PEG ALGORITHMS

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 VALUATION - USES

TOP-D O W N
BOTTOM-UP INVESTING TECHNICAL
INVESTING

ASSET VALUE FUTURE C O M PARABLES DAY

EQUITY VS
SOTP VALUE TRADING,
OTHER
INSTRUMENTS MARKET
COUNTRY TIMING,
ALLOCATION MERGERS & EVERYTHING! ALWAYS GREED VS
SECTOR ACQUISITIONS, VALUING RELATIVE SO FEAR,
ALLOCATION BALANCE GROWTH, CAUTION! BUY /SELL
SHEET FRANCHISE CHEAP OR LEVELS,
CYCLICALS, POTENTIAL, VALUE & EXPENSIVE FOR OVERBOUGHT
BANKS, LIQUIDATION, BRANDS, A REASON, & OVERSOLD
C O N SUMERS, VALUING CASH EVA IS PUREST P/E MOST USED
AUTOS BUT MOST FAST MOVING
HOLDING MATURE FLAWED, COMPANIES,
COMPANIES, COMPANIES, EV/EBITDA IS ANY
REAL ESTATE STABLE CASH CLEANEST COMPANY
COMPANIES, FLOW, DURING
TAKEOVER REGULATED STOCK MARKET
TARGETS INDUSTRIES SELECTION VOLATILITY

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 Equity Analysis
TELEFONICA - Valuation CaseStudy
Macro:What questions should we be asking?
ECONOMIC CYCLE: Return to growth?At what speed?Asia versus
Europe versus US.

POLITICS: Regulatory Risk?Tariffs,Network access.

INTEREST RATES: Long term low rates outlook positive fordebt.

But is inflation on the rise?

TELCOMS: Sector demand outlook…positive? From luxuryto

necessity? Emerging markets?

TECHNOLOGY:Voice Over IP,5G, FreeWiFi….threats and

opportunities for telecom operators
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 Equity Analysis
TELEFONICA - Valuation CaseStudy
Micro: How do we judge returns on capital?

EVA: EconomicValueAdded

ROCE (Return on Capital Employed_ - WACC (Weighted Average Cost of Capital)

ROCE 8,1% (NOPAT over EV)…ie. profit on investedcapital.

WACC: 4,4%
50% Debt 3,5% (average interest rate)
50% Equity 5,3% (dividend yield plus zero growth)

8,1% - 4,4% = 3,7% annual value creation

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 Equity Analysis
TELEFONICA - Valuation CaseStudy
Micro: Can we build statistical case?

What would you look to correlate with?

Other telcos? Sector trends…

Internet penetration? Telefonica in emerging markets…

House building? New fibre optic lines to be installed…

Consumer spending? Is telecom now a basic good…

Telefonica debt? EV stable, as debt rises equity falls….

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 Equity Analysis
Follow the newsflow…
Telefónica negocia salir de Costa
Rica, Nicaragua y Panamá por 500
millones
La teleco holandesa KPN se
dispara en bolsa tras los rumores de
OPA del fondo Brookfield
Elliott Ups Telecom Italia Stake
as It Battles Vivendi for Control
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Vodafone España anuncia un
ERE para un máximo de 1.200
empleados, el 23,5% de la
plantilla
Telefónica concreta venta de
sus activos en El Salvador y
Guatemala
Telefónica mejora un 11,6%
su beneficio y gana 2.721
millones hasta septiembre
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 Equity Analysis
TELEFONICA - Valuation CaseStudy
Follow the technical picture for timing

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Equity Analysis
Stock screening

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Equity Analysis
Stock screening

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 Equity Conclusions
So how do you make money in the Equity Markets?
✓ Obviously no single answer, but the compounded returns of the global
category killers is the best place to start.
✓ Identify the next cross-cycle investment theme… internet shopping, electric
cars, robotics, bio-tech, space exploration, whatever is going to draw a huge
flow of capital in the future.
✓ Identify the winners in that sector…the best products, the most dynamic
management, the highest barriers to entry.
✓ Then Buy and Hold….preferably forever, or at least until you can see what will
change the company’s position of dominance.
✓ Get the balance right between the growth driving the company and the value of
paying a reasonable price.
✓ Warren Buffett´s 20% plus annual average return for more than 50 years
proves it can be done. Despite avoiding new tech until mainstream (late buy of
Apple for example), he proves that the key is the ability to identify the winners.
✓ Buy brands, buy management, buy future cash flow.
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 Case Study:
The Patient Investor
• WARREN BUFFETT: TheSage of Omaha
• Worth more than $80bn, currently 3rd richest man in
the world
• Born 1930, bought first shares at 11 years old
• Finished University with $10,000 savings (about
$100,000 today)
• Worked as investment analyst until forming Buffett
partnership in 1956
• In 1962 Buffett bought textile firm Berkshire Hathaway
which would become his future investment vehicle.
• Took major stakes in leading companies in world of
media, consumer and insurance.
• Believed that good management, good brands and low
valuations would always provide long term returns…
• $10,000 invested with Buffet in 1964 would be worth
$240 million today, with compound annual returns of
about 20%
• Lesson: Try to see how companies will evolve over the
long term and ignore short term market moves
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 Investing Wisdom
“There are only two rules in investing. Rule #1: Never lose money; Rule #2: Never forget rule #1.” – Warren Buffett
"If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks.” -John Bogle (Vanguard)

"If you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without
looking at your cards.“ -Peter Lynch (Fidelity)

"The stock market is filled with individuals who know the price of everything, but the value of nothing.“ -Robert Fisher

"An investment in knowledge pays the best interest.“- Benjamin Franklin

"All intelligent investing is value investing - acquiring more that you are paying for. You must value the business in order to value
the stock.“ -CharlieMunger

“Be fearful when others are greedy. Be greedy when others are fearful.“ – Warren Buffett

"The four most dangerous words in investing are: 'This time it's different.’“ -John Templeton

"If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring.“ -George
Soros

"Every once in a while, the market does something so stupid it takes your breath away.“
- Jim Cramer

“Sometimes your best investments are the ones you don’t make.” - Donald Trump

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 Case Study:
Amazon is the perfect Equity example
• Founded by JeffBezos in Seattle in 1994
• Started as an online book seller using his parents’ garage as an
office. Expanded to sell CD’s, electronics, videos and then to
almost any retail good including food.
• IPO in 1997 at $18 per share
• Didn’t make any profit as a company until 2001, as all revenues
were invested back into expansion.
• Now the biggest retailer in the US with about 6% of ALL
consumer spending, and about 40% of all internet spending
• More than 1.1mn employees and total revenues of nearly $400
billion
• Amazon Prime delivery service is held by 115mn American
homes, or 88% of all households. $20bn in revenues just from
Prime, and Prime members spend 150% more a year. Clients pay
to be able to spend more…the perfect business model.
• Shares traded as low as $5 when internet bubble burst in 2000
and investors lost money for first 5 years.
• Now trades at $3180…180x IPO amount and became world’s
second $1 Trillion company after Apple.
• Lesson: Learn to spot the winners in any sector. What
companies will survive and dominate in a new market
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