1. Share Investments 1 Share Investments 1 Subtopic 6.1 - Investing in the Securities Market 1 Test 1 Project

2. Overview of Unit Purpose of the market Reasons for investment Buying / selling shares – various methods Calculating breakeven point Moving Averages, price-earning ratio Yield Dividends Rights or bonus issues and the effect on share price Taxation – Capital Gains / Dividend Imputation Index Numbers – All Ordinaries, sector indices Construction and calculation of share index Inflation Comparison of indices to gauge performance

3. The Purpose of the Share Market Primary Market –Raises capital for a company: Issue a prospectus via an underwriting broker. Investors subscribe for shares A company may want to raise 5 million – so they float 20 million shares @ 25cents each. Investors can remain as shareholders of the company or sell the shares on the Secondary Market.

4. Secondary Market: Is where issued shares can be traded via a stockbroker. It operates like an auction using the ASX’s computer trading system called SEATS (Stock Exchange Automated Trading System). When a sell bid matches a buy bid a trade is executed. The value of the share is influenced by demand, overseas economics, interest rates, company news….

5. Stockbroker Any transaction at the stock exchange needs to be carried out by a broker. They are members of the ASX and need to meet certain criteria to become a broker. They buy and sell shares for their clients and charge a fee. They can also : Give advice Act as an underwriter for new share issues

6. Listed Companies Not any public company can be listed on the exchange. They need to be of sufficient size. They need to meet a number of regulations : Have at least 500 share holders Have Capital of $1 million dollars Release half yearly financial reports Be run by a board of directors who decide on business strategy and such things as dividends etc.

7. Advantages of a public company listing –Funds are raised relatively easily –Investors are attracted to a well performing company –Key staff can be retained by offering share incentives Disadvantages of public company listing –Existing ownership is diluted –Directors are accountable to shareholders –ASX requires important information to be disclosed to the market. –Increased costs – listing fees, broker fees..

8. Trading on the Sharemarket Can bring good returns – Capital Gain Can bring regular income – Dividends A balanced portfolio can bring a regular income as well as a steady capital gain Diversified investments can help offset any major losses Long term investment is generally better than short term

13. What Shares? Deciding on what shares to purchase can be daunting. A newspaper share list gives a lot of information.

15. Year High / Low Stock Close / Move Buy / Sell Volume Sales High / Low Yield

16. What Shares? Media releases Stock Brokers / Financial Planner Newspaper – financial pages / share lists Types of shares Prospectus Website - research Yield Company History Formulas Annual Reports Company performance charts Volumes of shares traded High / Lows Blue Chip Seasonal Shares Long Term / Short Term Investments Business Operations Amount of money available

17. When to trade? After bonus / rights issues – share price drops Graphs Breakeven Price Averages Pre dividend / post dividend General market trends – crash – risk “Trade only money that you are willing to lose” Ethical trading

18. Types of Shares

19. Ordinary Shares Ordinary shares are the most common types of shares. When a company is floated – the majority of the share capital is made up of ordinary shares. –They are cheap (50c each) –Deliver dividends –Potential for capital gain –Dividends are paid after preference shares are paid out. –Have voting rights. Most investors opt for a portfolio that has a majority of ordinary shares.

20. Preference Shares Preference shares are not as common as ordinary shares. When a company is floated there is normally a percentage of the shares that are preference shares. –They are more expensive than ordinary shares. –Deliver dividends at a fixed rate. –Potential for capital gain. –Dividends are paid before ordinary shares. –Have limited voting rights. Some investors will have some preference shares to ensure a regular predictable dividend payment.

21. Rights Issues If a company wishes to raise more capital once a float has taken place the only option they have is to release a rights issue. This is where shares are offered at a discount to existing shareholders. BONUS ISSUES are similar to rights issues but they are free..

22. Terminology When the type of shares is written down – it normally takes the form of : 500,000, $2, 5% preference shares Number of shares Par Value Dividend rate 500,000, 50c, Ordinary shares Number of shares Par Value

24. Buying and Selling

25. Buying When you purchase shares you need to calculate how much it will cost you to buy the shares. You need to take into account the cost of the shares, brokerage and GST. Some brokers charge a fixed fee – internet transactions tend to do this. Most charge a % of the price of the shares. Make sure you do all the steps.

26. Cost of Shares

27. Example Calculate how much it would cost to purchase 5500 AMP shares at $3.20 each. Brokerage is 2% and a GST of 10% is applied to brokerage.

28. Consideration : 5500 x 3.20 = 17600 Brokerage : 2% x 17600 = 352.00 GST : 10% x 352 = 35.20 Total : (17600 + 352 + 35.20) $17987.20

29. Selling When you sell shares the only difference from buying is that you take away the fees charged. Consideration – Brokerage - GST

30. Example Calculate how much you would receive if you sold 7500 AMP shares at $4.20 each. Brokerage is 2.5% and a GST of 10% is applied to brokerage.

31. Consideration : 7500 x 4.20 = 31500.00 Brokerage : 2.5% x 31500 = 787.50 GST : 10% x 787.50= 78.75 Total : (31500 – 787.50 – 78.75) $30633.75

33. Breakeven Price

34. When you buy and sell shares to make a profit it is wise to calculate the minimum price they have to rise to so that you cover your costs. This is not a calculation that allows you to make huge profits – but the price that you need to sell them at so as not to make a loss.

35. Procedure Step 1 – First buy the shares. Step 2 – Add on the fees involved in buying again. Step 3 – Divide this by the number of shares purchased – this is the selling price needed to cover your costs (round up if needed). Step 4 - Sell the shares at this new price Step 5 – Check to see if you breakeven (if not just add 1c)

36. Consideration : 3400 x 8.77 = 29818 Brokerage : 2% x 29818 = 596.36 GST : 10% x 596.36 = 59.64 Total : (29848 + 596.36 + 59.64) $30474.00 You buy 3400 KMB shares for $8.77 – calculate the breakeven price. (2% brokerage 10% GST) Step 1 – First buy the shares. So when we sell them we need to get at least $30474.00

37. Total = 30474.00 Brokerage = 596.36 GST = 59.64 31130.00 Step 2 – Add on the fees involved in buying again.

38. Total (from 2) 31130 / 3400 = 9.1559 Number of shares So the new price should be $9.16 – but we need to check by selling the shares at this price (if in doubt round up!) Step 3 – Divide this by the number of shares purchased – this is the selling price needed to cover your costs (round up if needed).

39. Consideration : 3400 x 9.16 = 31144 Brokerage : 2% x 31144 = 622.88 GST : 10% x 622.88= 62.29 Total : (31144 – 622.88 – 62.29) $30458.83 We bought them for 30474.00 and sold them for 30458.83 – so we have NOT covered our costs – if we add 1 cent to the selling price we raise another $34 - (3400 x 0.01 = $34) – and if we add that onto 30458.83 we break even with about $15.17 spare – so our BEP will be $9.17 Step 4 - Sell the shares at this new price Step 5 – Check to see if you breakeven (if not just add 1c)

41. Other Indicators When to buy and sell

42. Yield It is hard to compare the prices of shares to see if your investment has been or is a good one. You really need to take into account the cost of purchasing the shares and the annual income.

43. This type of question means that you need to calculate the cost of buying AND the income you will get in the form of a dividend. There s a shorter method – that does not take into account the fees that you pay when you buy shares. (less accurate)

44. Price Earnings Ratio This ratio is commonly used to ascertain a stock’s relative value, and therefore whether it is over priced. Calculation of Price Earning Ratio It is calculated daily by dividing the share price by the earnings per share, where earnings per share is the net profit, earned by the company, divided by the number of ordinary shares on issue for the company. The price earnings ratio shows the number of times the share price covers the earnings per share. Eg if a P/E ratio is 14 for BHP shares this indicates that it will take 14 years for the earnings to cover the share price. Assuming the price and returns remain constant.

45. The P/E ratio is calculated daily and can be listed in share tables and is calculated by dividing the market value of the company by it’s earning per share. The earnings per share are calculated by getting the previous year’s net profit for ordinary shareholders and dividing this by the number of ordinary shares. High P/E ratio may indicate that investors are expecting high growth in earnings in the future. You can really only compare companies from the same industry sector. If the industry is stable then the P/E ratio may be low – like banks. But if there is speculation and a lot of movement then the P/E ratio may be high.

46. Market conditions will have a strong influence on relative P.E ratios – it does give a snap shot regarding the economic growth of the company.

48. Company Charts Companies will produce charts that show you how the shares are performing. There are a variety of charts that can help give insight into what is going on allowing you to make better informed decisions regarding trading. As with all decisions, the broader the information you have the “better” the decision can be.

49. Candlestick Charts These charts give you a lot more information than just a graph that uses the closing price. It shows the opening price, high, low and closing price. The rectangle body shows the open and close price. If it is green it means that the shares closed higher, if red lower. If clear then it hasn’t moved. So this shows you a quick snapshot of the shares. The whiskers or wicks show the highest and lowest price they traded at.

50. Moving Average This is a widely used indicator that can assist in determining the direction of a trend. When used in conjunction with other indicators it can generate buy and sell signals to the investor. This indicator is used by many people in their final determination of whether to trade. They would only act if the moving average is trending in the direction of the signal or if the price is on the same side of the moving average as the signal is indicating. The moving average has a smoothing effect and can be used to remove noise from the market, by reducing a basic open/high/low/close bar graph a simple line graph. The simple moving average uses the close price to calculate its value over a given time. Depending on the nature of the trader different time frames will be used to determine the length of the moving average.

53. In the example above, the blue line is the fastest and uses an 8 period moving average. A 21 period moving average was used to make the red line and finally a 55 period, in this case day, moving average was used to plot the green line. The green line is the best indicator to the longer term trend, which has turned from up to neutral. The shorter duration lines generated a sell signal back above 32500, when the blue line crossed below the red line. The signal was more or less confirmed when the short term line, the blue line, crossed below the green, long term line. 8 Day 21 Day 55 Day

56. Profit Distribution Division of Company Profits

57. When a company makes a profit, the owners are entitled to a share of these. If you are a shareholder – then you are a part owner of the company – and so are entitled to get a portion of the profits. The profits are divided up – thus the name DIVIDEND. The Board of Directors decide on how much of the profit to keep for tax / expansion or paying off loans. The rest is released to the shareholders.

58. Total Profit Tax + Other Expenses Preference Share Holders Ordinary Share Holders

59. Firstly preference shares are paid out according to their fixed dividend rate. ($2, 5% preference shares) Any remaining profit will then go to the ordinary shareholders – by calculating the dividend per share. There are only a couple of ways in which these questions can be asked – so it is in your best interests to be able to do these confidently.

60. A company has 200,000, $2, 5% preference shares and 1,000,000 50c ordinary shares. They make a profit of $4,300,000 and keep $800,000 for assets and 30% for tax. Calculate: 1.The amount that will go to all shareholders 2.How much all the preference shareholders will get 3.How much will go to the ordinary shareholders 4.The Div per share for the ordinary shareholders 5.The dividend you would get if you had 400 preference shares and 3000 ordinary shares 6.What is the paid up capital of the company?

61. A company has 200,000, $2, 5% preference shares and 1,000,000 50c ordinary shares. They make a profit of $4,300,000 and keep $800,000 for assets and 30% for tax. Calculate: 1.The amount that will go to all shareholders 4,300,000 – (30% x 4,300,000) – 800,000 4,300,000 – 1,290000 – 800,000 = $2,210,000 2.How much all the preference shareholders will get 200,000 x 2 x 5% 200,000 x 2 x 0.05 = $20,000 to all preference share holders

62. 3.How much will go to the ordinary shareholders 4.The Div per share for the ordinary shareholders $2,210,000 – 20,000 = $2,190,000 for all ordinary share holders There are 1,000,000 ordinary shares so the $2,190,000 is divided between All the shareholders. 2,190,000/1,000,000 = $2.19 per share (this is very high because I made it up!)

63. 4.The dividend you would get if you had 400 preference shares and 3000 ordinary shares The preference shareholders get paid the same amount each year : Preference Shares Number of Shares x par value x dividend rate 400 x 2 x 5% 400 x 2 x 0.05 = 40.00 Ordinary Shares Number of shares x div per share 3000 x 2.19 = 6570.00 Total dividend = 40 + 6570 = $6610.00

64. A company has 200,000, $2, 5% preference shares and 1,000,000 50c ordinary shares. They make a profit of $4,300,000 and keep $800,000 for assets and 30% for tax. Calculate: 5.What is the paid up capital of the company? The paid up capital is how much money was raised when the company was floated. You have to find how much money came from the preference shares and the ordinary shares. Preference Shares 200,000 x 2 = $400,000 Ordinary Shares 1,000,000 x 0.5 = $500,000 Paid up capital – 400,000 + 500,000 = $900,000

66. Shares and Taxation Taxation implications of owning shares

67. Income Tax Any income that you make is able to be taxed. Everyone is entitled to the first $6000 of income being tax free – Tax Free Threshold. With shares returns from dividends and capital gains are both classed as income and as such are both able to be taxed.

69. Capital Gains Tax (GCT) is a tax levied on any capital gain (profit) made on an investment. Laws relating to capital gains seem to continually change. Some of the general changes are: Shares purchased pre 1985 are not subject to CGT. Shares purchased pre September 1999 the Capital Gain can be calculated using the indexation model or the discount model. Capital Gains Tax

70. The INDEXATION MODEL takes into account inflation and the “real” gain in price of the shares to calculate the CGT. * Shares that are purchased after September 1999 and held for less than 12 months have the capital gain calculated on the entire gain. Capital Gain = total return – total cost

71. For shares purchased after September 1999 and held for more than 12 months the DISCOUNT RULE applies – you find 50% of the gain and pay tax on that (or just divide by 2) Capital Gain = (total return – total cost) / 2

72. Once the capital gain has been calculated, investors pay tax at their marginal rate (the tax bracket they are in) Capital Gains Tax = capital gain x marginal tax rate

73. Example 16 Fred purchased 3000 AMP shares at $6.75 each. Brokerage is 2% and a GST of 10% is applied to brokerage. 9 months later he sells them for $8.98. Fred’s marginal tax rate is 42% a)Calculate the capital gain b)Calculate the CGT owing c)Calculate the after tax return

74. Consideration : 3000 x 6.75 = 20250 Brokerage : 2% x 20250 = 405 GST : 10% x 405 = 40.50 Total : (20250 + 405 + 40.50) $20695.50 Step 1 – Buy and Sell the Shares Consideration : 3000 x 8.98 = 26940 Brokerage : 2% x 26940 = 538.80 GST : 10% x 538.80 = 53.88 Total : (26940 – 538.80 – 53.88) $26347.32 Step 2 – Sell the Shares

75. Capital Gain = Total Return – Total Cost Capital Gain = 26347.32 – 20695.50 = $5651.82 Step 3 – Calculate the Capital Gain Capital Gains Tax = Capital Gain x marginal tax rate Capital Gains Tax = 5651.82 x 42% = $2373.76 Since the shares were held for under 12 months no discount rule applies and tax must be paid on the entire capital gain. b) c) After Tax Return = Total return – total cost – CGT After Tax Return = 26347.32 – 20695.50 – 2373.76 After Tax Return = $3278.06

77. Capital Losses Most investors at some point make poor decisions regarding investments and make a loss. The decision needs to be made to hold on to them and hopefully they will rise in value or sell them. If you sell them for less than you bought them for it is called a CAPITAL LOSS.

78. A capital loss can be used to offset any capital gains – this reduces the amount of CGT payable. Capital losses are offset against the full value of any discountable capital gains. (i.e. before the 50% rule is applied) If your capital losses exceed your capital gains in a year – then the net capital loss (the amount left over) will be carried into the next financial year. It is best to offset the loss against any gain that the 50% rule doesn’t apply to.

79. You buy some AAA shares for $4599 and then sell them 18 months later for $3000, and at the same time buy BBB shares for $3980 and sell them 18 months later for $6234. If your tax rate is 34% calculate the tax payable. AAA Shares Capital Gain (loss) = 3000 – 4599 Loss = $1599 (no tax payable) BBB Shares Capital Gain = 6234 – 3980 Gain = $2254 So you need to pay tax on BBB – BUT you can off-set your loss 2254-1599 = 655 is your tax liability But as you have held them for more than 1 year – the discount rule applies. 655/2 = 327.50 Tax payable = 327.5 x 0.34 = $111.35

82. Tax on Dividends Before 1987 a company would pay tax on their profits (dividends) and then you as a shareholder would pay tax on your income – so the Government was kind of getting 2 lots of tax out of one payment. DIVIDEND IMPUTATION - is a method that gives tax advantages to shareholders who receive dividends. FULLY FRANKED Dividends have the tax paid on them by the company at the company rate 30%. This means when you get the dividend tax has already been paid – giving you the possibility of : –not paying tax on the dividends –Paying reduced tax on the dividends –Getting money back in the form of a tax return –Depending on your marginal tax rate

83. If your marginal tax rate is below the company tax rate you will get a refund! This system has benefits for shareholders, making dividend payments more attractive.

84. ClassRateNo of SharesUnfranked amount Franked amount Imputation credit Ord15 c2530$379.50$162.64 Calculate the tax owing and then the after tax return if you had the shares above and had a marginal tax rate of : (a) 17% and (b) 47%. Income declared = Unfranked amount + Franked amount + Imputation Credit Income Declared = 379.5 + 162.64 = 542.14 Tax Liability = Income declared x marginal tax rate Tax Liability = 542.14 x 17% = $92.16 Tax Owing = Tax liability – Imputation Credit Tax Owing = 92.16 – 162.64 = -70.48 You are owed $70.48.

85. ClassRateNo of SharesUnfranked amount Franked amount Imputation credit Ord15 c2530$379.50$162.64 Calculate the tax owing and then the after tax return if you had the shares above and had a marginal tax rate of : (a) 17% and (b) 47%. Income declared = Unfranked amount + Franked amount + Imputation Credit Income Declared = 379.5 + 162.64 = 542.14 Tax Liability = Income declared x marginal tax rate Tax Liability = 542.14 x 47% = $254.81 Tax Owing = Tax liability – Imputation Credit Tax Owing = 254.81 – 162.64 = 92.17 You are owe $92.17

86. Calculating the Imputation Credit In all these calculations we assume that the Business Tax rate is 30% 0.24 x 1260 302.40 x 30/70 30 is the tax rate