10.1 Equity

Question 1

Reasons for buying back shares

Answer 1

• Excess cash that can’t be used profitably»_space;>returned to shareholders
• Excess cash earning less compared to company’s other assets. Disposing of cash»_space;> improves EPS for remaining shares
• Tax-efficient way of returning capital to shareholders if tax treatment of capital gains is more favourable than that of dividends
• Company may want to change capital structure from equity to debt financing

Question 2

Categorisation

Answer 2

• Industry
• Market capitalisation
• PE ratio (or dividend yield)
• Gearing
• Overseas earnings
• Location
• Other: marketability, consumer demand etc

Question 3

Advantages of industry categorisation

Answer 3

 By analysing one industry, prepare basis for analysing many companies within industry
 Statistics are usually presented for whole industries and trade journals are “by industry”
 Accounts are often presented in similar format and use the same jargon
 By looking at industry»_space;> reduce # of factors to be considered for each individual company analysis
 Investment analysts can specialise

Question 4

Disadvantages of industry categorisation

Answer 4

 Analysts can be warped up in one industry, reducing proficiency in others
 Some companies operate through several factors
 Companies may not conform to industry norms in every respect
 Industries are correlated, but overall market movements explain most of the share price movements.

Question 5

Reasons for industry categorisation

Answer 5

• Practical

* Correlation of investment performance within industries

Question 6

Practical reasons for industry categorisation

Answer 6

• Factors affecting one company will likely be relevant to other companies in same industry
• Much of the information for companies in same industry will come from common source and presented in a similar way
• No single analyst can be expert in all areas, so specialisation is appropriate.
• Grouping of equities according to common factor gives structure to decision-making process. It assists in portfolio classification and management.

Question 7

Correlation of investment performance within industries

Answer 7

• After adjusting for market movements, the share price movements of companies in same industries correlate closely than with companies outside industry.
• Share price movements reflect changes that occurred in operating environment.
• These changes affect companies in the same industries in similar ways.
• So major markets also have separate indices for different sectors.

Question 8

Reasons why factors affecting one company are likely to affect others within industry

Answer 8

 Resources- Use similar resources (e.g. labour, land, raw materials)»_space;> similar input costs
 Markets- Supply to same markets»_space;> affected similarly by changes in demand
 Structure- Similar financial structures»_space;> affected similarly by changes in interest rates