CISI – Financial Products, Markets & Services Topic – Equities (4.1.4 and 4.1.3) Owning shares and Dividend Yields

Dividends Capital Gains Shareholder Benefits Shareholder Rights Part of the return for the risk capital Typically paid annually (or semi-annually). Paid out of the company’s profits which forms part of their distributable reserves (profits after tax and dividend payment). If profits for a particular year are low, a company can use it’s undistributed profits to pay dividends – Naked or Uncovered dividend Companies aim to pay steadily growing dividends. A fall in dividends can lead to negativity and shares may be sold. This is made on shares if their prices increase over time. Shares need to be sold to realise any capital gains. If shares are not sold then the capital gains are ‘Unrealised’. If capital gains are realised, then capital gains have been ‘banked’. Benefits of Share Ownership Shareholder Benefits Shareholder Rights Perks given to shareholders Trade benefits e.g. discounts on products and services. Nice bonus but not normally a major factor made in investment decision-making Entitlements for shareholders Pre-emptive rights to subscribe for new shares if the company wants to issue more. This can de one through a rights issue. Voting rights on matters at company meetings (Normally One share = One vote). They can vote by proxy.

Price Risk Liquidity Risk Foreign Exchange Risk Issuer Risk Shares may be difficult to sell at a reasonable price or sold quickly enough to prevent a loss Typically occurs to the shares of ‘thinly traded’ companies (Ltd companies not often bought or sold or listed plcs where there is not much trading activity.) Can occur when share prices in general fall. Share prices may fall – investors can lose capital even when dividends are paid Economic downturn Domino effect of collapsing markets in one country. When a company discloses bad news. Price risk varies between companies – ‘defensive’ shares hold less price risk e.g. utility companies and general retailers Risks of Share Ownership Foreign Exchange Risk Issuer Risk Currency price movements Issuing company may collapse – ordinary share become worthless This can have a negative effect on the value of an investment. Wipe out or reduce a gain. Could enhance a gain if the movement is in the opposite direction. Risk less significant with large companies but some recent high profile cases. Risk higher with shares in newer companies (Not yet reported profits).

Comparing dividends with other potential investments Benefits of share ownership – Focus on Dividends Comparing dividends with other potential investments Potential shareholders will compare the dividend paid on a company’s shares with alternative investments e.g. other shares, bonds and bank deposits. Calculating the Dividend Yield: Dividend Market Capitalisation (Total value of the company’s shares) X 100 Dividend Yield = Example: BT has 20 million ordinary shares, each trading at £2.50. BT pays out a total of £1m in dividends. £1m 20m x £2.50 X 100 Dividend Yield = £50m Dividend Yield = 2%

(Dividends / No. of shares) 100 Benefits of share ownership – Focus on Dividends Calculating the Dividend Yield on a per share basis: (Dividends / No. of shares) Share price X 100 Dividend Yield per share = Example: BT has 20 million ordinary shares, each trading at £2.50. BT pays out a total of £1m in dividends. (£1m/20m shares) £2.50 X 100 Dividend Yield = £0.05 Dividend Yield per share = 2%

Higher than average yields: Benefits of share ownership – Focus on Dividends Higher than average yields: Company is mature – generates healthy levels of cash but limited growth potential. Company has a low share price for another reason – expected to be unsuccessful. A high dividend is not expected to be sustained. For example: Utility suppliers (water and electricity companies)have their prices regulated by the government and demand for water and electricity tends to grow at a steady but low rate. Lower than average yields: High share price – company is viewed by investors as having strong growth prospects. A large proportion of profits are being put back into the business rather than paid out in dividends.

Benefits of share ownership – Focus on Dividends Estimated Dividend Yield Rankings of FTSE 100 Companies in 2012 Taken from: Bloomberg Business The average estimated yield is 3.99%. Cairn Energy Plc offered the highest estimated yield at 29.49% Shire Plc provided the lowest at 0.62%