Equity Securities Market 1 PDF

FUNDAMENTALS OF FINANCIAL MARKET
Chapter 7
EQUITY SECURITIES MARKET
Equity Security Market

known as
i " ei ng perspective, shareholder's equity, or more commonly
equity, refers to the difference between the assets and liabilities of a company.
Fundamentally, equity represents ownership of a firm. Same with debt, investors can put
out cash to purchase equity and trade these in financial markets through equity
instruments.
Equity instrument is a type of financial instrument wherein the issuer (company)

agrees to pay an amount to the investor in the future based on the future earnings of the
company, if any. The earnings used as basis of the amount to be paid to equity instrument
holder is determined after settling all required payments (i.e. interest for debt security
holders) of the business. The most common example of equity instruments is shares.
Basically, shares (or stocks) represent ownership in a company. May it be one

share, 10% of total outstanding shares or all authorized shares, having shares means that
@ party owns a portion of the business. An individual or a party who owns a share is called
a shareholder or stockholder. Shareholders own a percentage interest in a company in
relation to the total outstanding shares. Stock certificates, the legal document which
certifies the ownership of specific number of shares of a corporation, is given to
shareholders. In equity instruments, the company is the issuing party and the shareholders
who purchased the shares are the investors.
Authorized capital stock refers to the total maximum amount stated in the
Articles of Incorporation that can be subscribed to or paid by investors of a corporation if
the shares have a par value. Par value is the nominal value of the share that is indicated
in the face of the stock certificate. A company cannot issue additional shares in excess of
its authorized capital stock. Companies may increase its authorized capital stock by
amending its Articles of Incorporation and seeking approval from regulatory agencies.
lf the shares do not have a par value, the corporation does not have an authorized
capital stock, but it has an authorized number of shares it may issue.
Outstanding shares refer to the total shares of stock issued under binding
subscription agreements to subscribers or stockholders, whether partially or fully paid.
Outstanding shares do not include treasury shares. Treasury shares are shares that are
repurchased or bought back by the company from its stockholders. Issued shares refer to
all shares that were issued by the company, whether outstanding or treasury shares.
ons:
In the Philippines, there are three major forms of business organizati
e Sole proprietorship
Type of business organization which an individual personally owns a business.

has no distinct personality from the owner, thus, the owner
The sole proprietorship
owner has full
is responsible for all debts and obligations (unlimited liability). The
business.
control regarding decision making of the
FUNDAMENTALS OF F| NANCIA
LMARKET
¢ 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 and Ownership
among themselves. Though the partnership is a separate legal entity from the
partners, the partners are still personally obliged to pay for the debts of the
partnership. In case of bankruptcy, creditors can compel the Partner
s to pay up to
the extent of their personal assets.
e Corporation
Legal entity has a personality separate and distinct from the owners
/ shareholders.
Limited liability, i.e. legal provision that protects shareholders
from losing more
than they invested in the com pany, exists. Responsibility of
shareholders to
creditors is only up to the extent of their capital contribution.
This means that even
if the corporation goes bankrupt, shareholders will only lose up to
the extent of the
amount they spent in buying shares. Ownership in corporations
is evidenced
through shares.
Among the three, only corporations can issue shares. Investors prefer to put their money
on shares because of the concept of limited liability.
Why Invest in Equity Instruments?
Investors may earn from equity instruments through two methods: Capital appreciation and
dividends.
Capital Appreciation
Capital appreciation refers to the rise in the value of an asset in relation to the
increase in its market price. Since shares can be traded in the secondary market, investors
may sell shares they originally bought to other investors who are interested to buy. As long
as the buyer and seller agree on the price, the trade can occur. The price at which they
can trade is based on the interaction of different market factors. Asa result, market prices
of shares can be very volatile and may change from time to time. It is not 100% certain all
the time that market price of shares will go up. This uncertainty increases the risk
associated with shares.
For example, Investor A bought 1,000 shares from Company X at Php 10 per
share. After six months, share price increased to Php 12 per share. In this case, capital
appreciation occurred since share price increase by Php 2 per share; the total value of the
investment in equity securities increased by Php 2,000. If Investor A sells the shares at
Php 12, he will realize the Php 2,000 gain and receive the money. Otherwise, the Php
172 |
2,000 becomes un
realized gain. Gain or loss will only be realized or finalized when shares
are sold. Unrealized gains
eels or losses are temporary and may still go up or down based on
the prevaili ick.
@ Market price of the shares at a given point in time.
price aoe Ee Investor A held on to the shares for another six months and the share
1 ° hp 14. As a result, total unrealized gain decreased from Php 2,000 to
Php 4 000
ahare | hi = is still capital appreciation as the prevailing market price of Php 11 per
share ts higher than the original investment cost of Php 10 per share.
lf Investor A still did not sell shares for another six months, and the share price
dipped to P8 share, then Investor A now has an unrealized loss of P2 share or P2,000. In
this Gase, capital depreciation occurred, or the investment lost value because of lower
market price of the share. The risk of capital depreciation also exists when it comes to
investment in equity securities. As long as Investor A does not sell these shares, the
unrealized loss is still temporary and can be recovered if the market price of the share
increases in the future.
Dividends
Dividends are payments made by corporations to shareholders representing

excess earings of the company. Dividends are usually paid out quarterly, but some
companies pay it semi-annually or annually. Dividends are distributed to shareholders
based on discretion and approval of the board of directors. In some cases, management
can recommend amount to be declared as dividend still subject to final approval of board
of directors. Dividends can be in the form of cash, property (usually share investment in
another company) and own shares of the company. Cash is the most common type of
dividend. Dividends are only paid out once all claims from debt such as maturing interest
and principal repayments are settled.
Dividends are not dependent on capital appreciation of the share; instead, it is

based on the current performance of the business. Dividends may be declared even if
share price is going down as long as the company is allowed to declare dividends. The
ability to declare dividends may be restricted by covenants in loan agreements entered by
the corporation. The restrictive rule in dividend declaration is designed to make sure that
to
the company will have the money to pay the creditors first before distributing cash
shareholders. In instances wherein, the company report successive losses, they may
temporarily suspend declaring dividends.
In the Philippines, corporations are encouraged to declare dividends when needed
accumulated earnings tax (IAET). The IAET is a
through the imposition of improperly
penalty tax imposed on corporations who intend to accumulate excess earnings to enable
to avoid paying the 10% final tax on dividends that they might have
its shareholders
received if these were declared.
is based on the discretion of the board of directors,

Since dec laration of dividends
companies may opt to delay declaring dividends. As a result, the government loses cash
10% is
that it should have earned from the tax on dividend. To prevent this, an IAET of
are found to be guilty of
imposed on the improperly accumulated earnings if corporations
173 |
improperly accumulating earnings. Improper accumulation means the unjustifiable

accumulation beyond the reasonable needs of the business.
According to Section 43 of the Corporation Code, stock corporations are not

allowed to maintain retained earnings more than 100% of its paid-up capitalization at par
(any additional paid-up capital or excess over par is excluded). Corporate taxpayers have
one year from the end of the taxable year to dispose excess retained earnings: whether
through appropriation of retained earnings for business expansion or redemption of long-
term debt via board resolutions or dividend declaration. The 10% IAET is pattemed to the
10% final tax on dividends which the government should have received if the dividends
were declared properly.
Comparison between Debt vs. Equity

In debt, creditors or lenders possess the legal right to receive payment on the
amount that they invested or lent out. This means that the payment is required, and the
issuing business is compelled to repay once the debt becomes due. For equity.
shareholders only have an expectation of being repaid in the future. There is no clear
certainty that the money they used to pay for the shares can be recovered in the future.
The value that shareholders may enjoy depends on the future performance of the
company. This distinction makes equity instruments riskier compared with debt
instruments.
Other distinctions between debt and equity is summarized below:
Debt Equity
Voice in management No Yes
Creditors do not have voting Since shareholders are

privileges on company owners of the company, they
matters. They only rely on the possess voting rights on
contractual obligation certain decision s that affect
inherent to the debt. the company such as election
of company directors and
other special issues.
Claim on Assets and Prioritized over Equity Subordinate to Debt
Income
Claims of the creditors, i.e. Claims of the creditors should
interest on debt and principal be satisfied first before board
repayment, shall be paid first of directors can distnbute
before claims on income of dividends to shareh olders .
shareholders are satisfied.
Upon liquidation,
lf a company fails then shareholders only receive
liquidates, creditors also any remaining proceeds after
have a prioritized claim on satisfying principal and
assets over equity holders. interest claims of creditors.
This means that once assets
are sold, proceeds will be ___
174 |
| Debt Equity
used to settle the following in
order: secured '__— creditors,
unsecured creditors and
shareholders.
Type of Financing Temporary Permanent
Maturity Has a maturity date when the | Has no maturity date.
issuing company needs to
repay the debt Although shares have a
ready secondary market,
prices at which the shares
: can be sold at may fluctuate.
Risk Profile Lower risk relative to equity Higher risk relative to debt
Return of invested money | High uncertainty of returns

(and interest) of creditors is | associated with shares
more certain because of the | (yearly earnings and
contractual obligation | proceeds from asset
inherent to debt. liquidation).
Fluctuating price of shares in

secondary market
As a result, shareholders
expect higher return (i.e. high
interest rate) from shares vs.
debt.
Return Expectations lower compared to equity Higher compared to debt
Return is only up to] Return (dividends and capital

contracted interest. appreciation) may increase
infinitely as long as_ the
business keep on growing.
Tax Implication Can be used as_ tax-| Dividend payments to
deductible expense by the | shareholders cannot be used
issuing company, thus, | as tax deductible expense by
reduces their income _ tax | the issuing company.
payable to the government.
Types of Shares
Investors should have an idea what type of shares they want to put their money on
based on their investment objectives. There are two types of shares that corporations can
issue: preference (or preferred) shares and ordinary (or common) shares. Both shares
represent ownership of the corporation but differ in several aspects.
175 |
RE a
Preference shares
Preference shares give its holders distinct rights that enable them to be prioritized
over ordinary shares. A fixed periodic dividend, whether percentage or peso amount, is
promised to holders of preference shares. Par-value preference shares have stated face
values and the annual dividend is expressed as a percentage of the face value. On the
other hand, no-par preference shares do not have stated face value; its annual dividend
is usually stated in peso amount per share. Since dividends on preference shares are
fixed, its share price is usually stable.
Normally, preference shareholders do not have voting rights, but corporations can
opt to give them voting rights explicitly in the Articles of incorporation. Companies often
choose to issue preference shares if they need additional financing, but they do not want
to dilute ownership of the corporation.
As mentioned, preference shares have senior rights over ordinary shares.
Preference shares are treated as quasi-debt, the required dividend associated with
preference shares is like the interest on debt. This should be settled first prior to settling
any claims by ordinary shareholders. However, unlike debt, preference shares do not have
a maturity date. Issuing preference shares commonly costs the firm more than if they issue
debt.
In instances of liquidation of the assets of the corporation, the claim of preference
shareholders is only up to the par value of the preferenceshares. Preference shareholders
will be paid before ordinary shareholders but only once liabilities to creditors and lenders
are fully settled.
When preference shares are issued, an agreement like a bond indenture is made
which contains relevant information such as par value of the share, amount of dividend,
date of payments and other restrictive covenants to ensure continued existence of the
business and consistent dividend payments. The restrictive provisions include omitting
payment of dividends, minimum liquidity requirements, mergers and acquisitions, sale of
assets and repurchases of ordinary shares. Violation of any of these provisions usually
allow preference shareholders to have representation in the board of directors or force the
corporation to redeem the preference shares held by the shareholders at an amount
higher than its par or stated value.
Other features that may be included with preference shares are the following:
e Cumulative. All dividends in arrears (i.e. dividends not paid in previous periods).
together with the current dividend, should be paid prior to paying dividends to
ordinary shareholders. If preference shares are non-cumulative, this means that
the corporation can pass on paying dividends on preference shares and will only
be required to pay the current dividend, not the dividend in arrears.
e to retire or repurchase outstanding
Callable. Allows the issuing corporatofiona time
shares within a predetermined period at a specified price. Usually, the
call price is established higher than the issuance price but may gradually decrease
end the
over time. Callable preference shares permit the issuing corporation to
fixed-payment commitment associated with preference shares if marke
conditions make it favorable to do so.
176 |
* C
number ef saps shareholders to convert the preference shares to a stated
that the prey Nary shares after a certain date. The number of ordinary shares
based Preference shares can be exchanged into may also change over time
©d On @ predetermine formula.
Ordinary Shares
paitiua arene nares represent the true owners of a corporation. They are called as
end orelerencn rodacgn they will only receive what will remain after all claims of creditors
atiniatnicere “OS cee on the income and assets are satisfied. It is possible that
Aah i would be multiples times richer if the business goes well in the future.
ough, If upon liquidation, the corporation has no leftover assets, ordinary shareholders
also get nothing. Dividends are also not guaranteed for ordinary shareholders unlike
preference shareholders. The only assurance that ordinary shareholders have relies on
the concept of limited liability — they can only lose up to the extent that they have invested
in the company. Because of the level of uncertainty associated with returns related with
ordinary shares, shareholders usually expect to have higher returns in the form of
dividends and capital gains
Ordinary shares can be
¢ Privately owned. Owned by private investors and shares are generally,

not publicly traded (if to be traded, transactions are usually between private
investors only and consent of the organization is needed)
e Closely owned. Owned by an individual investor or a small group of private
investors like a family
e Publicly owned or publicly traded. Owned by mix of public and private investors
and shares are actively traded in stock market
e Widely owned. Owned by many unrelated individual or institutional parties
Ordinary shareholders generally possess the voting rights to decide on certain

corporate decisions like electing the board of directors, issuance of new shares or
change in fundamental corporate direction. As a result, ordinary shareholders are
granted preemptive rights. Preemptive right permits ordinary shareholders to retain
their proportionate ownership in the firm in case of new share issuances, hereby
protecting them against dilution of ownership. Dilution of Ownership occurs when
fractional ownership of an existing shareholder is reduced as a result of the company
issuing additional shares. Preemptive rights allow existing shareholders to maintain their
current voting influence and protect them from dilution of earnings i.e. reduction of claim
on earnings as a result of lowering of its fractional ownership.
To exercise the preemptive right, companies give stock rights to the shareholders.
A stock right is a financial instrument which permits shareholders to buy additional shares
from the company at a price cheaper than the market price, in direct proportion of the
number of shares they own. Rights is very important for companies who need financing
but intend to protect the ownership percentage or proportionate control of the
shareholders in the company. Companies of use rights as a better financing option as this
offering sha res .
is cheaper compared with public
177 |
FUNDAMENTALS OF FINANCIALMARKET
Basically, each ordinary share grants one vote to the shareholder. Votes can be assigned
and cast during shareholders’ meeting. Since small shareholders often do not attend the
shareholder meeting to vote, they can opt to sign a proxy statement to transfer their votes
to another shareholder. Solicitation of proxies is controlled by the Securities and
Exchange Commission to make sure that the solicitation is not based on misleading
information.
In recent years, other types of ordinary shares were offered to shareholders to suit
different objectives.
e Supervoting shares. Shares that have multiple votes associated with one share.
This allows controlling shareholders to maintain control against any outside group
who may plan for a hostile takeover. Hostile takeover occurs when an outside
group tries to gain controlling ownership of a company without the support of the
management by buying more shares from existing shareholders.
e Nonvoting ordinary shares. Shares that have no voting rights. Offered by
companies that want to raise capital but does not want to give up any voting
control.
Stock Market
The stock market is composed of exchanges and over the counters where shares
are issued and traded publicly. The actual stock market is both physical and virtual as
electronic trading of stocks has been increasingly relevant due to the easy access to
technology. The stock market can be considered both a primary and secondary market.
However, since most of the transactions are buying and selling existing stocks of investors
(compared with new share issuances), the secondary market is considerably bigger than
the primary market.
The physical site where shares are purchased and sold face-to-face on a trading
floor is called a stock exchange. The most well-known organized exchange is the New
York Stock Exchange. Before, buyers and sellers who participate in organized exchanges
meet in a specified location and uses an open out-cry auction model to trade securities.
Since exchange is already transitioned to a more virtual mode of trading, this method is
less frequently used.
Organized exchanges, being auction markets, employ floor traders that oversee
and facilitate the trading of specific shares. The floor traders, who are representatives of
different brokerage firms, meet at the trading post on the exchange and gather the current
bid and ask prices. The quoted prices are called out loud. In around 90% of trades, the
floor traders match buy and sell orders from their clients. In the remaining 10%, the floor
traders buy the shares themselves or sell shares from their inventory. Floor traders are
responsible to maintain an orderly market for the share even if it requires buying shares
in a declining market.
178|
An over-the-
dealers that are co nnected
counter market refers to the market wherein shares can be traded by
electronically by computers. Dealers (also called as market
mak€rs) operating in an OTC market try to “make a market” by matching the buy and sell
orders they receiv € from investors. Dealers keep an inventory of shares that they trade in
the OTC market
to balance buy and sell orders.
to set bid and ask prices. There can be multiple
wondiclicadinn fe re usually responsible
syste m. Once each shall provide their bid and ask quote in the
ria @ given stockareandrequi
the cme 2 iS is done, they red to buy or sell a minimum of 1,000 securities
as price. Once trade is executed, they can enter a new bid or ask quote in the
system. Dealers earn through two means: through the spread between the bid price (price
to pay for shares) and ask price (price at which shares are sold at) and through
commissions On trades.
Dealers are ve important in e
success of the OTC rivet. Dealers ensure a Point of Information!
there is continuous liquidity for each available The most popular OTC market in
stock in the market. Dealers allow small shares the world is the National
with liquidity that can help them get accepted in Association of Securities Dealers
the market. Without dealers whois alwaysready | Automated Quotation System or
to buy/sell shares, investors would be reluctant | NASDAQ. NASDAQ provides the
to purchase shares from unknown firms. This current bid and ask prices for
makes it difficult for start-up firms to gather | spout 3,000 actively traded
necessary funding. securities.
Aside from organized exchanges and
OTC markets. new modes to trade stocks have surfaced due to the advancement of
technology and changing appetites of investors. These are electronic communications
networks and exchange traded funds.
Electronic communications network (ECN) is a network which directly links

major brokerage firms and traders and removes the need for a middleman. ECN has been
gaining ground lately because of the following reasons:
e Transparency. Traders in the ECN can easily view if there are unfilled orders
timely. This input allows them to understand supply and demand for the shares
and modify their strategy accordingly. Some exchanges also provide this
information but not as timely and complete as ECN can provide.
Cost reduction. The removal of middleman and commission reduces the

transaction costs associated with the trade. Spread is also reduced and sometimes
removed.
Faster execution. Trades are matched faster and confirmed quicker since the
Individual trades are done with minimal human
ECN is fully automated.
intervention. This is very critical for investors who trade on smail price fluctuations.
179 |
e After-hours trading. Trading can continue at any time of the day because of the
availability of ECN. Traders can react accordingly based on news reports and
information that come out after trading hours of exchanges.
However, ECNs can only work well with shares that has a substantial amount of
trading volume. Since ECN also requires matching between seller and buyer, thinly traded
stocks may go for long periods without trading.
Exchange-traded funds (ETF) 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. ETFs are listed and can be traded as individual shares in the
exchange. ETFs are often indexed instead of being actively managed. ETFs are valued
based on the underlying net asset value of the shares inside the index portfolio.
Information about the shares inside the ETF is publicly available so that intraday arbitrage
can help keep ETF price close to the implied value.
ETFs do not have minimum investment amount unlike mutual funds. Although they
are somewhat like stock index mutual funds, ETFs can be preferable since they can be
traded like a normal share — limit orders, short sales, stop-loss orders and ability to
purchase on margin. ETFs also have lower management fees than comparable index
mutual funds. However, since ETFs trade like stocks, they are subject to commission to
brokers when they are being traded.
In terms of value, the top 10 largest stock markets in the world are the following:
New York Stock Exchange

a OOMNOOSWN>
Tokyo SE Group
NASDAQ OMX
NYSE Euronext (Europe)
London Stock Exchange
Shanghai Stock Exchange
Hong Kong Exchanges
TSX Group (Canada)
BME Sapnish Exchanges
0. BM & FBOVESPA
The overall performance of a stock market is measured through stock market

indexes, which represents the average of stock prices currently being traded. The value
of a stock market index is usually set at 100 in a base year. Stock market indexes intend
to show movementsof price over time instead of the actual stock value. It is forthis reason
why the year selected as base year is not as relevant. If stock prices increase by more
than 20%, it is usually called bull market or bullish. Onthe other hand, the decline of more
than 20% of stock prices means it is a bear market or bearish.
Investors use stock market indexes to gain some insight on how a group of stocks
could have performed in the market. Different stock market indexes may contain different
mix of companies or group of stocks.
Understanding the performance of the stock market is important as it can have
further implications in other segments of the economy. Economists believe that changes
180 |
stocknen priier ae i spending households and

S incabved affect the economy since it affects
while declining share
prices may lead ete share prices may influence higher spending production level
higher
employment oevice spendin g. Increased spendingj means :
and ; versa. Im pact of changes in stock prices can be felt at the
following levels:
a. Large corporations treat the stock market as an essential fund source for
expansion projects. High share prices allow them to receive higher funds they can
use for capital investments such as machineries and plants and research &
developments when they issue new shares.
b. Ata macro level, shares account for significant portion of household wealth. Share
increase,
prices and household wealth has a positive correlation. If share prices
household wealth also increases and vice versa. Household tends to spend more
Consequently,
if they have higher wealth than spend less if their wealth declines.
movements in share prices affect household spending.
C. Fluctuations in share prices affect expectations of consumers and business. This

is perhaps the most important consequence of movements in share prices.
c
Historically, significant declines in share prices are usually followed by economi
recessions. As a result, consumers who observe significant decline in share prices
This
tend to have more uncertainty regarding the future of their jobs and income.
. They spend
uncertain outlook makes consumer moreconscious on their spending
less on consumer durables like vehicles, appliances and furniture. The reduced
employment. Lower
spending consequently leads to decline in production and
as the funds they
share prices also deter firms in spending on capital investments
will receive if they issue new shares are lower.
Philippine Stock Exchange
nal and sole stock exchange

The Philippine Stock Exchange or PSE is the natio in Asia starting
of the oldest stock exchanges
of the Philippines. PSE is considered as one
ange. The trading floor of PSE is currently
in 1927 when it was still Manila Stock Exch is composed of a
l City, Taguig. The PSE
situated in the PSE Tower in Bonifacio Globa
T. Pardo as Chairman.
45-man Board of Directors with Jose
nge was created in 1992 due to the merger of the
The Philippine Stock E xcha
two for mer sto ck exc hanges: The Manila Stock Exchange (MSE), established
country’s d on
ust 8, 192 7, and the Makati Stock Exchange (MkSE), which was establishe
on Aug
May 27, 1963.
a “Self-Regulatory Orga nization” or SRO status by the SEC
PSE has bee n granted
. Th is meeans
a the PSE cani mple ment its own rules and set penalties on erring
in June 1998
d listed com panies.
trade participants an tion.
be an on -p ro fi t, no n- st oc k, member-governed organiza
Formerly, PSE used to areholder-based,
PSE med
was transfor its current structure which is a sh
to
In 2001,
181 |
revenue-earning corporation headed by a president and a board of directors. PSE

eventually listed its own shares in the exchange under the ticker PSE.
The PSE through the Philippine Central Depository (PCD) uses the computerized
book-entry system to transfer ownership of securities from one investor to another, thus,
eliminating the need for physical exchange of scrip between the seller and buyer. Scripless
trading describes the system where settlement is carried out via book-entries, rather than
by the movement of physical certificates. However, investors may still request for an
upliftment of their shareholdings to get a physical certificate.
The PSE regulates trading activities through the Capital Markets Integrity
Corporation (CMIC), a spinoff of the Market Regulation Division of PSE, to monitor and
penalize trading participants that violate the Securities Regulation Code and its
implementing rules and regulations; the Anti-Money Laundering Law and its implementing
rules and regulations; the Code of Conduct and Professional Ethics for Traders and
Salesmen; CMIC Rules; and other relevant laws and regulations. The CMIC shall also
have the authority to investigate and resolve trading-related irregularities and unusual
trading activities involving issuers based on complaints received, findings and reports.
The CMIC oversees the market through a world-class and sophisticated
surveillance system called Total Market Surveillance (TMS), which was developed by the
Korea Exchange. TMS is equipped with the critical elements of the surveillance process
and provides a robust monitoring and warning mechanism. It is designed to safeguard the
integrity of the stock market from fraud, manipulation, and breaches of marketplace rules
of erring market players. The CMIC conducts investigation of unusual price and volume
movements to identify and sanction trading participants, issuers or investors who might
have committed unfair market practices.
CMIC, with the approval of the PSE President, shall have the power to restrict, halt
or suspend the trading of a listed security of an issuer or the trading by a trading participant
of a particular listed security in cases of unusual trading activities or possible trading-
related irregularities.
Other initiatives to safeguard interests of the investors include:

e Enforcement of static and dynamic thresholds to protect against unusual
share price fluctuations. The Static Threshold enforces a 50% trading band
within which the price of a stock is allowed to move. When the stock price increases
by 50% (price ceiling) or decreases by 50% (floor price) on a particular day, to be
determined from the last closing price or the last adjusted closing price, the trading
of the stock shall be automatically frozen by the PSE upon reaching said limit,
unless there is an official announcement from the listed company or the proper
government agency which would justify such price fluctuations. The Dynamic
Threshold is the maximum allowable price difference between an update in the
Last Traded Price (LTP) of a given stock or group of stocks and its preceding LTP
that is equal to a percentage set by the PSE, subject to the classification of a stock
or a group of stocks based on its trade frequency. The Dynamic Threshold of a
listed stock may vary from 10% , 15% and 20% depending on its trade frequency.
182 |
FUNDAMENTALS OF FINANCIAL
* Disclosure requirement for publicly listed companies. The PSE requires that
Material information, which may affect a listed company's stock price positively or
negatively, are disclosed within 10 minutes after its occurrence. Disclosures must
also be done first to the PSE so that it will cascade information to every investor
and general public through its communication channels and not to a selected group
of individuals only. This is very important to ensure the fairness and efficiency of
the trading happening in the market. The PSE ensures that listed companies
promptly disclose only factual and truthful information. Non-compliance with or
violations of the disclosure rules are heavily penalized with fines, trading
Suspension, or even delisting from the PSE.
e Securities Investors Protection Fund, Inc. or SIPF. The SIPF, which is

comparable to the Philippine Deposit Insurance Corporation providing insurance
for bank deposits, seeks to build and enhance investors' confidence in the market
and is envisioned to protect the investing public from extraordinary losses, other
than the ordinary market fluctuations, arising as a result of fraud, failure of
business, or judicial insolvency of PSE-accredited stockbrokers. Protection to
investors is automatic upon the opening of an account with a PSE-accredited
stockbroker and given by way of compensation for trade-related obligations of
stockbrokers to its customers.
Corporate Compliance
Companies who plant to list publicly in the Philippine Stock Exchange should:
a. Comply with the laws, regulations and full disclosure rules and policies of the
Philippine government
b. Have standards of quality, operations, and size under efficient and effective
management;
c. Conduct issuance, offering and marketing of securities in a fair and orderly
manner and ensure that securities are widely and equitably distributed to the
public
d. Give adequate, fair and accurate information about the company and its
securities to the general public to enable them to make informed investment
decisions
e. 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 holder 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 — The company must have cumulative
consolidated earnings before interest, taxes, depreciation, and amortization
(EBITDA), excluding nonrecurring items, of at least P50 Million for three (3) full fiscal
years immediately preceding the application for listing and a minimum EBITDA of
10 Million for each of the three fiscal years. The applicant must further be engaged
in materially the same businesses and must have a proven track record of
management throughout the last three (3) years prior to the filing of the application.
To show this, the company submits audited consolidated Financial Statements for
the last three (3) full fiscal years preceding the filing of the application to the PSE.
The Financial Statements must be accompanied by an unqualified external auditor's
opinion
Exception to the 3-year Track Record Requirement — The following are the
exceptions to the three (3) year track record rule:
e The company has been operating for at least ten (10) years prior to the filing of
the application and has a cumulative EBITDA of at least 50 Million for at least
two (2) of the three (3) fiscal years immediately preceding the filing of the listing
application.
e The company is a newly formed holding company which uses the operational
track record of its subsidiary.
Positive Stockholders’ Equity — The company must have a positive stockholders’

equity in the fiscal year immediately preceding the filing of the listing application.
Market Capitalization — At listing, the market capitalization of the company must

be at least P500 Million.
Operating History — The company must have an operating history of at least three
(3) years prior to its application for listing.
Minimum Capital Requirement — The company must have a minimum authorized

capital stock of 500 Million, of which a minimum of twenty-five percent (25%)
must be subscribed and fully paid.
Minimum Offering to the Public — The minimum offering to the public for initial listing
shall be based on the following schedule:
| Market Capitalization Public Offer
Not exceeding P 500 M 33% or P50M whichever is higher
Over ®500M to P1B 25% or 100M whichever is higher
Over 1B to P5B 20% or 250M whichever is higher
Over f5B to f10B 15% or 750M whichever is higher
Over f10B 10% or 1B whichever is higher
shall have at least

Minimum Number of Stockholders — Upon listing, the company
to at least one
one thousand (1,000) stockholders, each owning stocks equivalent
(1) board lot. The requirement to have at least one thousand (1,000) security
one (1) board lot is only
holders each owning securities equivalent to at least
at all times, maintain 3
required upon listing. Once listed, companies shall,
the public of ten percent (10%)
minimum percentage of listed securities held g by share
the listed companies issued and outstandin s, exclusive of any treasury
shares, or as such percentage that may be prescribed by the Exchange.
184|
I. Valuation of Assets — When required by the PSE, the company shall engage the
services of an independent appraiser duly accredited by PSE and SEC
determining the value of its assets.
j. Full Payment of Issued and Outstanding Shares — The company shall cause all its
subscribed shares of the same type and class applied for listing to be paid in full.
k. Investor Relation Program — The company shall have an investor relation program
to ensure that information affecting the company is communicated effectively to
investors. Such program shall include, at the minimum, a corporate website that
contains, at the minimum, the following information:
e Company information — organizational structure, board of directors,

and management team;
¢ Company news — analyst briefing report, latest news, press releases,
newsletter (if any);
e Financial report — annual and quarterly reports, at least for the past 2
years:
e Disclosures — recent disclosures to the Exchange and the
Commission for the past 2 years;
Investor FAQs — commonly asked questions of stockholders;
Investor Contact — email address for feedback/comments,
shareholder assistance and service; and
e Stock Information — key figures, dividends, and stock information.
A company that incurs negative stockholders’ equity for three (3) consecutive years shall
be subject to delisting, in accordance with the rules of the Exchange. The delisting of the
company’s securities shall take effect thirty (30) days from approval by the PSE Board of
Directors of the said delisting. The Exchange shall send notice of such delisting
immediately to the listed company and the Securities and Exchange Commission. The
Exchange shall likewise publish an announcement relative thereto on the Exchange
website.
Disclosure Rules
All companies listed in the PSE is 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. This principle shall apply to all the required
disclosure requirements of listed companies.
Corporate disclosures are classified into two: the structured and the unstructured
corporate disclosures. Structured continuing disclosures are reportorial requirements
submitted within specific time frames such as annual, quarterly and monthly reports.
Unstructured continuing disclosures are communications of corporate developments as
they happen and are intended to update the investing public on the activities, operations
y.
and business of the compan
Structured continuing disclosures include the following:
e Annual report (SEC Form 17-A) ~ To be submitted within 105 days after end of
fiscal year Lusi
e Three Quarterly Reports (SEC Form 17-Q)— To be submitted within forty-five (45)
days from end of the first three (3) quarters of the fiscal year
e Reports on Beneficial Ownership
e Other periodical reports to update and keep current information on the operation
of the business and financial condition of the company.
On the other hand, the objective of requiring unstructured disclosures is 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. A material fact or event is one which would reasonably be expected to affect
investors’ decisions in relation to those securities. This includes, but is not limited to, any
significant and relevant information relating to the business and operations of the Issuer
that, if and when disclosed, would result in or would reasonably be expected to cause a
significant change in the trading and/or market value of the company’s securities.
Disclosures must be made promptly by the issuing company if it meets any of the following
standards:
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, prospects, development projects, contracts entered into in the ordinary
course of business or otherwise, mergers 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 inforrnation is necessary to avoid the creation of a false market for its
securities; or
c. Where such information may reasonably be expected to materially affect market activity
and the price of its securities.
Everts that prompt disclosure if required from listed companies include:
Change in the control of the cornpany
Filing of legal proceeding against the cornpany involving a claim amounting to
10% coripany’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 decision taken to carry out extraordinary investments or the entering into
finaricial or commercial transactions that might have a material impact on the
company’s shuation
* nore OF pheritial lomses, the aggregate of which amounts to at least ten percent
(10%) A the consHidated total assets of the company
«© Dissctution
186 |
Acts and facts of any nature that might seriously obstruct the development of
corporate activities and its implications
Any licensing or franchising agreement or its cancellation which may materially
affect the company’s operations
Any delay in the payment of debentures, negotiable obligations, bonds or any
other publicly traded security
Creation of mortgages or pledges on assets exceeding ten percent (10%) or more
of the company’s total assets
Any purchase or sale of stock or convertible debt securities of other companies
when the amount is ten percent (10%) or more of the company’s total assets;
Contracts of any nature that might limit the distribution of profits,
Facts of any nature that materially affector might materially affect the economic,
financial or equity situation of those companies controlling, or controlled by the
Issuer including the sale of or the constitution of sureties/pledges on a substantial
part of its assets
Authorization, suspension, retirement or cancellation of the listing of the Issuer's
securities on an exchange or electronic marketplace domestically or abroad
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 meetings of
the Board of Directors and stockholders of the company
A joint venture, consolidation, acquisition, tender offer, take-over or reverse take-
over and a merger;
Capitalization issues, options, directors/officers/employee stock, option plans,
warrants, stock splits and reverse splits;
All calls to be made on unpaid subscriptions to the capital stock of the company;
Any change of address and contact numbers of the registered office of the
company;
Any change in the auditors of the company and the corresponding reason forsuch
change;
Any proposed amendment to the Articles of Incorporation and By- Laws and its
subsequent approval by the Commission;
Any action filed in court, or any application filed with the Commission, to dissolve
the
or wind-up the company or any of its subsidiaries, or any amendment to
Articles of Incorporation shortening its corporate term;
appointment of a receiver or liquidator for the company or any of its
The
subsidiaries;
Any acquisition of shares of another corporation or any transaction resulting in
such corporation becoming a subsidiary of the Company;
187 |
e Any acquisition by the company of shares resulting in its holding ten percent (10%)
or more of the issued and outstanding shares of another company or where the
total value of its holdings exceeds five percent (5%) of the net assets of an unlisted
corporation;
e Any sale made by the company of its shareholdings in another listed or unlisted
corporation: (1) resulting in such corporation ceasing to be its subsidiary; (2)
resulting in its shareholding falling below ten percent (10%) of the issued capital
stock;
e Firm evidence of significant improvement or deterioration in near-term earnings
prospects;
e The purchase or sale of significant assets amounting to ten percent (10%) or more
of the company’s total assets otherwise than in the ordinary course of business;
e Anew product or discovery;
The public or private sale of additional securities;
A call for redemption of securities;
The borrowing of a significant amount of funds not in the ordinary course of
business;
e Default of financing or sale agreements;
Deviation from capital investment funds equivalent to twenty percent (20%) of the
original amount appropriated;
e Disputes with subcontractors, customers or suppliers or with any other parties;
An increase or decrease by ten percent (10%) in the monthly, quarterly and annual
revenues on a year-on-year basis
Corresponding penalties are meted to listed companies that fail to comply with the
disclosure requirements of PSE.
Platforms for Capital Market
In trading or doing business in Capital Market, there are different ways on how to
conveniently facilitate the trading in the Capital Market.
Conventional Brokerage
in 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. Commissions are normally percentage of the amount being
traded. Since brokers are exposed to the workings of the stock market, they can provide
sound investment advice to their client-investors on what stock trading decision to take.
188 |
Online Trading
Due to the advent of technology, many investors are shifting towards digital
platforms to trade shares. Online brokers typically charge lower commission compared to
conventional brokers. However, they do not offer any investment advice and other
services that a traditional broker can give.
Mutual Funds
Instead of buying or selling individual stocks, investors can also opt to buy shares
in mutual funds. Mutual funds are an investment company that pools money from various
investors and invests them to 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
Market capitalization refers to the total market value of all outstanding shares of
a company. This is calculated by multiplying the total outstanding shares by the prevailing
market price per share. Market capitalization is an important indicator used by investors
to determine the size of a company. For example, if a company has 25 million shares
outstanding and each is worth P100, then the company's market capitalization amounts
to P2.50 billion.
Market capitalization allows investors to benchmark the relative size of a company against
another. This measures the worth of the company in the open market and the perception
of the market regarding its future prospects. Market capitalization reflects how much
investors are willing to pay for the shares.
Several factor 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
It is important for investors to understand how to value shares to be able to assess

reasonableness of the price being offered to them. Knowing different share valuation
techniques equip investors with the right knowledge that will help them choose the best
stocks that fit their investment appetite. Share valuation techniques are commonly
grounded in identifying how much cash flow can be received in the future if the investor
rchases the share now. Even though investorsvestors can earn through capital appreciation,
right to receive divi dend s.
the
they ultimately pay to earn the
re is equivalent to the present value of the future cash flows that can
The value of a sha
approach is most commonly called as the discounted
be received from an investment. This
cash flow approach. To identify
future cash flows, investors should be able to project items
that they can receive from an investment. All discussion assumes that cash will be
received at the end of the year.
One-Period or Multiple Period Valuation Model
Most investors tend to hold shares only as investment for a couple of years.
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 below formula.
p= —oF ; CFy od CR
o (4+n)! "A4+7r)7 (1 +t.)
Where P, = value of stock today
CF, = expected cash flow (dividend or proceeds from sale) per

share at end of yeart
Ts = required return on ordinary share
The required return represents the discount rate which investors expect to receive
in exchange for assuming risk in an investment. On the viewpoint of the company, this
represents the rate of return that they need to pay to investors to make their shares an
attractive investment.
Illustration 1. Investor TBA want to buy shares of Flix Company. When he looked it up at
the stock exchange, Flix Company can be bought at P30 per share. Further research
showed that dividends are stable at P5 per year and it is expected to be resold at P40 per
share aftera year. Investor TBA expects a 10% return on his investments and only expects
to hold Flix Company shares for a year. What is the value of the shares based on Investor
TBA’s computation?
Investor TBA expects two cash flows from this: first is from the dividend of P5 for the year
and the expected selling price of P40 after a year. The discount rate to be used is 10%.
We will only be using 1 year since both cash flows can be received after a year.
a; CF,
Po ~ (1+7,)! 1G +r;)}
Po
1, 5 40
~ G@ +10%)' + G+ 10%)!
5 ef et on 40
° (4.1097 T (to0yt
190 |
Po = 4.55 + 36.36
Po = 40.91
ae rs yt ine share Currently is at P40.91. Investor TBA should consider buying this
of P30 is lower than the true value of the shares at
P40.91., | urrent selling price
/.41. Investor TBA may be able to receive return from the spread between the current
selling price and the real value based on the share valuation technique.
Dividend-based valuation techniques
The most common share valuation technique is through dividends. Future dividends are
the most relevant input for share valuation. Dividends embody future cash flows which is
the usual return that investors receive in a stock investment. However, timing of dividends
might be a little tricky for investors as there is no assurance when a company will declare
dividends.
The basic dividend-based valuation model uses this basic formula:
) —
Dy D we eee:
Des
o~ Gtr) Gtr + Gd+%e)”
D, = expected cash flow (dividend or proceeds from sale) per share at end of year
TY; = required return on ordinary share

The basic dividend- based valuation model can be further interpreted by anticipating how
much dividend will grow in the future. There are three 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.
Dividends of preference shares are expected to be received as long as the shareholders
hold the stock. The formula for zero-growth model is:
y=
D,
Oo %

D, = expected dividend per share at end of year 1
r, = required return on ordinary share
191 |
The equation above shows that the a zero-growth model assumes that the present value
of the share equates to the present value of perp
etuity of the expected dividend discounted
at the required return.
Ilustration 2, Investor CDE wants to buy 1,000 preference shares, P200 par value from
Korean Company. According to his sources, the preference shares come with a constant
dividend of P30 per share Investor CDE intends to hold the preference shares long-term
and has no plans on selling this in the near future. Investor CDE requires a 15% return on
all of his investment. What is the value of each preference share?
We can compute for the value of the preference share using the zero-growth model.
P, = P200 per share
The value of each preference share of Korean Company is P200. Assuming that Investor
CDE is also looking at the preference shares of Chinese Company that has par value of
P100 with 20% stated dividend rate. Same expectations on required return apply. What is
the value of each preference share of Chinese Company?
First, compute for the expected dividend of Chinese Company. Investor CDE expects to
receive P20 dividend per share (P100 x 20%). With this expected dividend as input,
calculate for the value of the preference share using the zero-growth model.
J —
D
PB ~~
P, = P133.33 per share
The value of each preference of Chinese Company is P133.33.

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 ass

. ume d to be rece ived right away and the next dividend will
be received after a year
192 |
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:
P59 =
Dy
(7%; — g)
D, = expected dividend per share at end of year 1
Ts = required return on ordinary share
g = expected dividend growth rate
Illustration 3. Investor TLC is looking at investing and buying shares from Nutela
Company, a publicly listed company. Based on publicly available information, Investor
TLC was able to compile the following dividend data for the last 6 years.
bale Dividend per

Share
2018 2.80
2017 2.58
2016 2.40
2015 2.24
2014 2.10
2013 2.00
Based on the available historical information, Investor TLC believed that the historical
annual growth rate of dividends is a good indicator of the future constant growth rate of
the dividends. This can be computed through the use of the compounded annual growth
rate (CAGR) formula. CAGR measures the compounded average growth for several
periods covered by the analysis.
Dividend, Current Period 1
CAGR = Gividend. First Period =) a—P —1
Availabl
Where n = number of years considered in the analysis.
Using the CAGR formula above, the CAGR computed for the last 6 periods is at 7%.
2.80 1
CAGR G0? 6-1 1
1
CAGR = (1.40)9) —1
CAGR = 7%
Assuming that growth rate will continue based on the historical trend, value of the common
stock can be computed as follows:
3
Po =
° (15% —7%
193 |
3
Po =
(8%)
Py = 37.50 per share
The dividend of P3 is used as the numerator since this is the expected Gividend to be
received in the next period. This is computed by muttiptying the previous dividend of P2.80
by the compute d historical growth rate of dividends of 7% and adding the result to the
previous dividend. Simply this is [Latest dividend x (1 + growth rate)).
Variable Growth Model
An inherent limitation associated with the zero-growth and constant growth mode!
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 ex pected dividends during the
initial
growth period and the computed value of the stock at the end of the initial growth
period.
Illustration 4. Vic Company is contemplating whether to buy shares in
Vin Company. Vin
Company recently paid dividends of P3 per share. After carefully studyin
g the business of
Vin Company, Vic came up with the estimate that dividends may grow
at 5% annual rate
in the next 3 years. At the end of 3 years, Vic expected that the market will
mature, and
organic growth will only lead to a constant 3% dividend growth in the foreseeable
future. Vic uses 12% required return in evaluating his investments.
Using the four steps mentioned above, we can compute for the value of the shares in Vin
Company.
1. Dividend from previous year x (1 + growth rate in the initial period) = Expected
Dividend
Year 1 P3 x 1.05 = P3.15
Year 2 P3.15 x 1.05 = P3.31
Year 3 P3.31 x 1.05 = P3.47
134|
2. Present value of dividends expected to be received for each year using

required
return of 12%
Year 1 P3.15 x 0.8928 = P2.81
Year 2 P3.31 x 0.7972 = P2.64
Year 3 P3.47 x 0.7118 = P2.47
Value of the stock at the end of Year 3 (last year of initial growth period) using the
constant growth model
Expected Dividend in Year4 = P3.47 x 1.03 = P3.57
7 P3.57
o~ 12% — 3%
_ P3.57
= 9%
Py = 39.67
The value of the stock at the end of the initial growth period is P39.67.
4. Combine the present value of the expected dividends during the initial growth
period and the value of the stock (which considered future expected dividends
growing at a constant rate) at the end of the initial growth period.
Py = PV of Dividend in Y1 + PV of Dividend in Y2 + PV of Dividend in Y3 + Share

Value at end of Initial Growth Period
Po = 2.81 + 2.64 + 2.47 + 39.67
Py = 47.59
The value of each share of Vin Company is P47.59.
Other Approaches to Share Valuation
Free cash flow
An alternative to using dividend-based share valuation techniques is the use of free cash
cash flow refers to the cash flow that are available for debt creditors and
flow. Free
shareholders after satisfying all other operating obligations. Free cash valuation is useful
the value of startup companies, companies without any dividend history
when computing
company.
or the operating division of a large
195 |
Free cash flow follows the same premise as the dividend-based valuation
techniques — computing for the present value of future cash flows that are expected to be
received from the company in an infinite time horizon. Instead of using dividends, the
model uses free cash flows which is the available cash to the providers of funds. The
present value is computed using the weighted average cost of capital (or WACC) of the
company. The WACC represents the average future cost of sourcing the funds.
The free cash flow valuation model estimates the value of the entire company as
a whole. Since it is the value of the entire company, it is necessary to isolate only the
value of ordinary shares. To do that, the market value of the debt and preference shares
should be deducted from the entire company value. This can be in the form of below
formula:
Market Value of Entire Company

—Market Value of Debt
—Market Value of Preference Shares
Value of Ordinary Shares
Free cash flow valuation also faces the same limitation as the dividend growth
model i.e. itis difficult to forecast cash flow for an extended period of time. For this reason,
methodologically, PV of free cash flow can be computed for the first five years and value
from Year 6 onwards will be computed using the constant dividend growth model. This is
the same method of computation as the variable growth model.
Book value per share
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 satisfying claims from creditors and
preference shareholders. Book value per share is very easy to compute since book value
can easily be derived from the accounting records. However, the drawback of this method
is that it lacks sophistication and its reliance on historical balance sheet data. 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 of preferences shares
Book value per share =
= Total No.of Outstanding Shares
Illustration. Atthe end of 2018, the balance sheet of Jamar Company showed total assets
of P3 million pesos, total liabilities of P2 million pesos, preference shares of P250
thousand and 100,000 outstanding shares. Book value can be computed using above
formula.
196 |
P3,000,000 — 2,000,000 — 500,000

100,000
500,000
Book value per share = 100,000
Book value per share = P5 per share
Liquidation value per share

Liquidation value per share pertains to the 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 remaining
shareholders. Liquidation value is a more realistic approach compared to book value since
this approximates that assets will be sold based on its market value. However, this
approach still lacks any consideration on the future earning potential of the company.
Illustration: Upon further evaluation, JamarCompany found out that the assets can
only be realized for P2.7 million, lower than its book value of 3 million. Based on
this data, liquidation value per share will be at
P2,700,000 — 2,000,000 — 500,000
Liquidation value per share =
100,000
200,000
100,000
Book value per share = P2 per share
Price Earnings (P/E) Multiples

The P/E multiples method 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. Investors can use the average P/E ratio of a particular industry as
reference point to determine a company’s value. This is under the assumption that
investors compute for the value of a firm through the same methodology assuming the
average firm in the industry is valued. 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 computed by
multiplying the expected EPS of the company by the average P/E ratio for the industry
where the company is similar. The average P/E ratios for the industry can be researched
from publicly available information.
One advantage of the P/E multiples approach is its simplicity. Share value can be easily
computed using this method once companies announce how much they earned for the
to an increase in demand for more frequent announcement

historical year. This led
regarding future earnings of a company.
/ Ipful in val uing non-publicly traded companies since not
P/E multiples is very helpful | Still, P/E multiples can still be used in. valuation of
much relevant information is available. b
:
publicly traded companies. The P/E multiples approach Is treated as a better methodology
compared to book value per share and liquidation value share since it considers expected
PE ratios in
earnings of the firm. Firmsin the same industry are expected to have similar
the long run.
:
A high than average P/E ratio may mean two things
future which will pull down
* Marketis expecting company earnings to increase in the
P/E to the normal level or _
has low risk and investors are willing to pay
Market feels that company earnings
premium for them
Limitations of Share Valuation
to the
Valuation models often measure share value at a specific point in time according
projected return and risk at that moment. Any decision that investors or the issuing
company may take can change the variables and ultimately, the value of the shares.
Changes in Expected Dividends — Increase in expected dividends brought upon
by positive management actions will increase the firm’s value under the
assumption that associated risk is unchanged. This means that changes in
expected dividends has direct relationship with share value.
Changes in Risks / Required Return — Actions taken by management that will
increase risk will cause share value to decline. Changes in risks is inversely
proportional to share value.
Problems with Growth Estimations — Estimating future growth using historical data
may fail to account for present changes in the company or economy that might
influence the growth rate.
Problems with Risk Estimations — Since share price is highly dependent on
required return, any minute error in risk estimations may result in a different share
price.
e Problems with Dividend Forecasting — Many factors can influence dividend payout
such as future growth opportunities and management’s concern regarding future
cash flows. Investors may find it difficult to accurately forecast dividends as
declaration is highly dependent on the decision of board of directors.
Decision making of investors do not consider risk, dividends or estimation problems
separately. Often, investors evaluate investments to ensure that it goes in the same
direction. As companies assume more risks, shareholders tend to expect higher dividends.
Investors should also be wary that all inputs in the valuation models are based on
estimates and careful consideration should still be employed before making any
investment decision.
Relevance of Share Valuation to Investors
In the stock market, share prices are usually set by the buyer who are willing to
pay the highest price. This price doesn’t necessarily mean that It is true price of the asset
but is incrementally greater than prices from other buyers, Market prices are set by buyers
who can take advantage of the asset. If buyers think that they can do more with the
investment, they are willing to pay for it even if they push the price higher, Lastly,
information plays a significant role how securities are priced in the stock market, Superior
or more information regarding an asset may increase its value by mitigating associated
risks. Investors who do not have background knowledge will tend to put a higher discount
on securities because of the associated uncertainties. On the other hand, investors who
have knowledge regarding events affecting the security may be able to place the right
discount rate and dictate the price accordingly.
Distinctively, prices computed in our share valuation techniques may or may not
approximate the price that is set for the share in the stock market. Nevertheless, share
valuation techniques are very important to investors since it gives them a sense whether
price being offered for a share is reasonable or not. Fundamentally, price derived through
share valuation techniques are considered fair since this considers expected cash flows
from the investment. If the market price is lower than price computed through the models,
the share is considered cheap or undervalued. Otherwise, if market price is higher than
the computed price, it is considered costly or overvalued. A share that is traded at a price
close to its computed price is considered as fairly valued. Investors tend to buy shares
when they are undervalued (to profit off when price becomes higher) and sell shares they
feel are overvalued (to cut off loss in case of decline towards the fair price).
These valuation models only reveal the relative value of shares but does not
provide any information on when or how long the current market price will approximate its
fair value. This leads to investors holding on to shares that are perceived to be cheap for
an extended period.
Mispriced stocks give investors an opportunity to take appropriate actions to

generate higher returns. Investors should consider how mispriced a share is for them to
know what action to take — whether to buy undervalued shares or sell short overvalued
shares. This decision may depend upon how far the trading price is from its fair value and
its associated transaction costs. Investors should also take into consideration that shares
may look as mispriced due to inaccurate estimates.
199 |

Equity Securities Market 1 PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Equity Securities Market 1 PDF

Uploaded by

Copyright:

Available Formats

FUNDAMENTALS OF FINANCIAL MARKET

Equity Security Market

Equity instrument is a type of financial instrument wherein the issuer (company)

Basically, shares (or stocks) represent ownership in a company. May it be one

Type of business organization which an individual personally owns a business.

Formed when two or more persons bind themselves to contribute money,

Why Invest in Equity Instruments?

Dividends are payments made by corporations to shareholders representing

Dividends are not dependent on capital appreciation of the share; instead, it is

is based on the discretion of the board of directors,

improperly accumulating earnings. Improper accumulation means the unjustifiable

According to Section 43 of the Corporation Code, stock corporations are not

Comparison between Debt vs. Equity

Other distinctions between debt and equity is summarized below:

Creditors do not have voting Since shareholders are

Return of invested money | High uncertainty of returns

Fluctuating price of shares in

Return is only up to] Return (dividends and capital

FUNDAMENTALS OF FINANCIAL MARKET

Ordinary shares can be

¢ Privately owned. Owned by private investors and shares are generally,

Ordinary shareholders generally possess the voting rights to decide on certain

Electronic communications network (ECN) is a network which directly links

Cost reduction. The removal of middleman and commission reduces the

Exchange-traded funds (ETF) happens when a portfolio containing various

New York Stock Exchange

The overall performance of a stock market is measured through stock market

stocknen priier ae i spending households and

C. Fluctuations in share prices affect expectations of consumers and business. This

Philippine Stock Exchange

nal and sole stock exchange

revenue-earning corporation headed by a president and a board of directors. PSE

Other initiatives to safeguard interests of the investors include:

e Securities Investors Protection Fund, Inc. or SIPF. The SIPF, which is

General Criteria for Admission to Listing in the PSE

Positive Stockholders’ Equity — The company must have a positive stockholders’

Market Capitalization — At listing, the market capitalization of the company must

Minimum Capital Requirement — The company must have a minimum authorized

shall have at least

e Company information — organizational structure, board of directors,

Platforms for Capital Market

It is important for investors to understand how to value shares to be able to assess

One-Period or Multiple Period Valuation Model

Where P, = value of stock today

CF, = expected cash flow (dividend or proceeds from sale) per

Dividend-based valuation techniques

The basic dividend-based valuation model uses this basic formula:

TY; = required return on ordinary share

Where P, = value of stock today

P, = P200 per share

P, = P133.33 per share

The value of each preference of Chinese Company is P133.33.

c. The first dividend is ass

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

bale Dividend per

Variable Growth Model

2. Present value of dividends expected to be received for each year using

Expected Dividend in Year4 = P3.47 x 1.03 = P3.57

Py = PV of Dividend in Y1 + PV of Dividend in Y2 + PV of Dividend in Y3 + Share

The value of each share of Vin Company is P47.59.

Other Approaches to Share Valuation

Free cash flow

Market Value of Entire Company