Topic 6 : Equity Markets
Malaysian Equities (Module 7)
Topic Objectives
• Discuss the importance and structure of Malaysian equity
markets
• Relate the concept of shares and the various equity hybrids
• Discuss the various share issues and its impact on market price
• Describe the role of valuation and its myths
• Apply the various approaches to valuation of equities
• Relate the importance of valuation in context and criticisms on
valuation
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Equity Markets
Malaysian Equity Markets
Introduction
Fund rising through equity ownership – the money paid to own the shares becomes the capital of the company and
the shareholders are the owners of the company
Stock market – bridges the gap between borrowers and investors i.e. facilitating the flow of funds
Stock
Increasing the quantity of
funds available to the market : Directing the flow of new
finance industry Basic savings
functions
Bursa Malaysia Securities Berhad
Main Market ACE Market
For established companies with track record Growth platform for companies
3
Equity Markets
Shares
Required Return by Shareholders
4
Equity Markets
Shares
Risk-return Characteristics
Total required
Rate of return
Derivatives
Ordinary shares
Corporate bonds
Risk-free rate Treasury bills
of return
No or Low Risk Medium Risk High Risk
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Equity Markets
Shares
Share Ownership
Advantages Disadvantages
Limited right to inspect company’s book
Bear all risk of company
Right to dividends and capital gains
Only receive dividend if profitable
Right to sell shares to anyone
Paid out last in the event of liquidation
Pre-emptive rights
Only receive dividend when declared by
Right to vote at AGM
BOD
Right to control company
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Equity Markets
Changes in Number of Shares Issued: Right Issue
Right Issue
Why? How?
Raising capital for Exercise some or all
What? expansion or loan rights
Privilege granted to repayment
Sell some or all rights
shareholders to acquire Giving existing
additional shares directly Buy additional rights for
shareholders
from issuing company trading or exercise
opportunity to acquire
additional shares at Do nothing and let rights
discount expire
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Equity Markets
Changes in Number of Shares Issued: Right Issue
1. Theoretical ex-rights price: reference price at which the shares will be traded ex-rights.
Example: Propose rights issue on the basis of one for two existing shares of Rm1 each at an issue price of RM1.50 per ordinary
share. The current market price is RM3 per share.
Ex-rights price = (2 x RM3) + (1 x RM1.50)
No of existing shares + No of rights
required for rights entitled
= RM2.50
2. Intrinsic value of rights: reference price at which the rights will be traded during the rights trading period.
Example: as above.
Intrinsic value of rights = Ex-rights price – Rights issue subscription price
= RM2.50 – RM1.50
= RM1
3. Date of trading of rights: second market day after the despatch of PLO or PAL pertaining to the right issue.
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Equity Markets
Changes in Number of Shares Issued: Retention Money
Retention money: amount to be deducted from the transacted value to protect buyer’s interest
1. Bonus issue – Example: Bonus issue of 1 for 2. Original holding (O) = 2, Bonus (B) = 1
Deduction ratio = B = 1 =1
O+B 2+1 3
Selling broker will deduct 1/3, buying broker 33.33% and between broker 1/3 of contract price.
2. Right issue – Example: Rights issue of 1 for 2. Original holding (O) = 2, Rights (R) = 1
Deduction ratio = R = 1 =1
O+R 2+1 3
Selling broker will deduct 1/3, buying broker 10% and between broker 1/3 of contract price.
3. Bonus entitled to rights/ Rights entitled to bonus –
Example: Bonus 1 for 4. Rights 1 for 1. Original holding (O) = 4, Bonus (B) = 1, Rights (R) = 5 (4 rights from O and 1 rights from
B) / Rights 1 for 4. Bonus 1 for 1. Original holding (O) = 4, Rights (R) = 1, Bonus (B) = 5 (4 rights from O and 1 rights from B)
Deduction ratio = B+R = 1+5 = 3 / Deduction ratio = B+R = 1+5 =3
O+B+R 4+1+5 5 O+B+R 4+1+5
Selling broker will deduct 3/5, buying broker (10% + 1/10) 20% and between broker 3/5 of contract pri ce /
Selling broker will deduct 3/5, buying broker (10% + 5/10) 60% and between broker 3/5 of contract price
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Equity Markets
Changes in Number of Shares Issued: Retention Money (cont.)
4. Rights issue and bonus issue taking place simultaneously but each not entitled to the other:
Example:
Rights of 1 for 2, Bonus of 1 for 4
Method 1 Method 2
Assume original holding (O) = 2 Assume original holding (O) = 4
Rights (R) = 1 Rights (R) = 2
Bonus (B) = ½ Bonus (B) = 1
Deduction ratio Deduction ratio
= R+B = R+B
O+R+B O+R+B
= 1 + 0.5 = 2+1
2 + 1 + 0.5 4+2+1
=3 =3
7 7
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Equity Markets
Changes in Number of Shares Issued: Bonus Issue
1. Does not result in company raising new finance.
2. Capitalisation of accumulated reserves, bring nominal capital in line with the value of capital used.
3. Once money is transferred from capital reserves to issued share capital account, it cannot be paid out a a
dividend.
4. Theoretical ex-bonus price – Example: scenario of a 3:1 bonus, market price = RM4 prior to the issue
Theoretical ex-bonus price = Market price x Original number of shares
New number of shares
= RM4 x 50,000
200,000
= RM1
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Equity Markets
Equity Hybrids
Preference Share and Convertible Unsecured Loan Stock
Preference shares – cumulative, non-cumulative, participating, redeemable, callable, convertible, PIK preferred stock.
Convertible Unsecured Loan Stock (CULS) – more saleable because of conversion privilege
Example: Market price = RM5, convertible basis = 2 CULS at nominal value of RM1 for 1 new ordinary share of RM1
each.
Intrinsic value of CULS = Market price of ordinary shares
Number of CULS required for conversion
= RM5 = RM2.50
2
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Equity Markets
Equity Hybrids
Warrants
Warrants – right to buy specified number of shares at a stated price within a specified time period.
Intrinsic value of warrant = (Market price of share – Exercise price) x (Number of shares each warrant
entitles the holder to purchase)
Warrant premium = Market price of warrant – Intrinsic value of warrant
Features of a Call Warrant
Underlying asset Exercise price Exercise period
American (exercise at
Issued on the any time up to/on
Price is fixed at the time No value after expiry
underlying maturity date),
of warrant issuance date
asset/security European (exercise on
maturity date)
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Equity Markets
Equity Hybrids
Theoretical Ex-entitlement Price
Example: ABC Bhd announcement:
1. Bonus issue of 24,640,000 new ordinary shares of RM1 each on the basis of 2 new shares for every 5 existing shares.
2. Right issue of 36,960,000 new ordinary shares of RM1 each at issue price of RM3.20 per share on the basis of 3 new shares for
every 5 existing shares.
3. Right issue of 123,200,000 nominal amount of 3% bank guaranteed redeemable unsecured loan stocks 20x1/20x5 (RULS) with
49,280,000 detachable warrants issued at 100% nominal on the basis of RM10 nominal amount of RULS and 4 warrants for every
5 existing shares held.
The bonus and rights issues are not entitled to each other. The cum-all price is assumed to be RM12.30 per share.
1. Theoretical ex-all price = (5 x RM12.30) + (3 x RM3.20) = RM7.11
5 + 3 (Rights) + 2 (Bonus)
2. Intrinsic value of rights entitlement to share = Ex-all price – Rights subscription price
= RM7.11 – RM3.20
= RM3.91
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Equity Markets
Equity Hybrids
Theoretical Ex-entitlement Price (cont.)
3. Assuming exercise price is RM3 on the basis of 1 warrant for 1 new share,
Intrinsic value of warrant = (Ex-all price – Exercise price) x (Number of shares each warrant entitles the holders
to purchase)
= (RM7.11 – RM3) x 1
= RM4.11
4. Assuming exercise price is RM3 on the basis of 1 warrant for 1 new share and offer price for each warrant is
RM0.50 per warrant,
Intrinsic value of warrant rights = Ex-all price – Exercise price – Offer price
= RM7.11 – RM3 – RM0.50
= RM3.61
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Equity Markets
Equity Hybrids
Theoretical Ex-entitlement Price (cont.)
5. Retention money:
Deduction ratio for buying broker and client = 2 (B) + 10% (R) + 10% (RULS) = 30%
20
Deduction ratio for selling broker and client = 2 (B) + 3 (R) + 10 (RULS) = 3 or 75%
20 20 20 4
Deduction ratio between broker to broker = 2 (B) + 3 (R) + 10 (RULS) = 3 or 75%
20 20 20 4
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Equity Markets
Classification of Shares for Investment Purposes
• Shares of major companies with long and unbroken records of high
Blue Chips earnings and good dividends
• Shares of companies whose sales and earnings are currently growing
Growth Shares faster than the economy and industry
• Companies whose earnings track the business cycle i.e. economic
Cyclical Shares conditions improve, earnings and share price rise and vice versa
• When the shareholders wish to live off current income from the
Income Shares investment
• Shares of companies whose future earnings are likely to withstand
Defensive Shares economic downturn with relatively moderate/low business and financial
risk
Speculative Shares • Has high probability of low/negative return which lead to overpriced
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Equity Markets
The Role of Valuation
From individual investor point of view – in deciding to buy
security
Reasons for valuation
In the context of portfolio management – in deciding investment
with optimum required rates of return
In the context of company restructuring, take-over/merger
exercise, divestment
In term of company performance – allow assessment for
continued profitability (product launching, new market entries,
joint ventures)
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Equity Markets
The Valuation of Equities
Basic Approaches
Fundamental analysis Technical analysis
Involves
Assumption: Any Assumption:
charts,
profitability Concerns mispricing sentiment/ Concerns Trends/
graphs,
Question of will with will be mood of with patterns
statistical
profitability determine intrinsic/tru corrected by investors perceived repeat
data to
the share e value the market drives share value themselves
predict
price takes in the future prices
share price
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Equity Markets
The Valuation of Equities
Valuation models Discounted Cash Flow Method DCF Model
Capital Asset Pricing Model
Weighted Average Cost of Capital
Dividend Discount Model
Constant Growth Dividend Model
The Gordon Growth Model
Two-stage dividend Discount Model
Comparative Methods Price Earnings Ratio (PER)
Price-to-book Value Ratio
Asset Basis Valuation Book Value or Adjusted Book Value
Replacement Value
Liquidation Value
Break-up Value
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Equity Markets
Valuation of Equities
Discounted Cash Flow Method
1. DCF model:
2. Cost of capital using capital asset pricing model (CAPM):
Required rate of return = Interest rate on risk-free securities + Market beta [Average
return on the market portfolio – Interest rate of risk-free securities]
3. Overall company cost of capital using concept of weighted average cost of capital (WACC):
WACC = [After tax cost of debt x Proportion of debt financing] + [Cost of equity x Proportion of
equity financing]
4. Dividend discount model:
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Equity Markets
Valuation of Equities
Discounted Cash Flow Method (cont.)
5. Constant growth dividend model:
6. Gordon growth model:
7. Two-stage dividend discount model:
where the terminal price:
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Equity Markets
Valuation of Equities
Discounted Cash Flow Method (cont.)
8. Present value of operating cash flows:
9. Present value of free cash flows:
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Equity Markets
Valuation of Equities
Comparative Method
1. Price earnings ratio:
Earnings per share (EPS) = Profit attributable to equity shareholder
Number of ordinary shares
Price earnings ratio (PER) = Market price per share
Earnings per share
Earnings yield = EPS = 1
Market price PER
Problems – PER should be seen as tied to company business cycle, limitations of EPS reflected
in PER, dilutive issues, limitations of EPS reflected in Earnings Yield
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Equity Markets
Valuation of Equities
Comparative Method (cont.)
2. Price-to-book value ratio:
Book value per share = Book value of assets – Book value of liabilities
Number of ordinary shares
Price-to-book value ratio (PBVR) = Market price per share
Book value per share
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Equity Markets
Valuation of Equities: Limitations of Comparative Methods
Use of conventional accounting information
Lack of specific information
Analysis of consolidated financial statements of a group of companies poses problems
The timing of financial reports
Different financial year end of different companies complicates comparisons
Lack of benchmark ratios for evaluation purposes
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Equity Markets
Valuation of Equities
Asset Basis Valuation
Book value or adjusted book value – assets minus liabilities
Replacement value – value business from the perspective of current replacement cost of assets
Liquidation value – what individual asset would be worth at auction or liquidation
Break-up value – assumes a company is worth more broken into portions and sold separately
than as a whole
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Equity Markets
Factors Affecting Valuation
Estimation of growth
rate
Stocks in the Estimation of discount
benchmark index rate
Stock liquidity and
Estimation of cash flows
freefloat
Earnings quality
28
Equity Markets
Related Issues
Equity
Sensitivity Valuation
Analysis not done
in Isolation
Criticism of
Valuation
Myths
Approache
s
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