1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 19:  Features and benefits of ordinary and preference shares 4.1.2  Dividends and dividend payments  Capital gains  Share benefits  Bonus / scrip capitalisation issues 19cis

2. Issuing shares to the public A Plc can issue two main types of shares to investors  Ordinary shares  The company’s Articles of Association will set out the rights of the ordinary shareholders  Preference shares  Same rights as ordinary shareholders plus some additional privileges, as specified in the Articles Investors will usually pay a premium price for the additional privileges attached to preference shares...

3. Who owns the company? However: In 2003, the House of Lords reaffirmed its 1948 ruling that “shareholders are not, in the eyes of the law, part owners of the company”. The House of Lords (which until very recently was the UK’s highest court) ruled that what shareholders own is their shares, and ownership of shares confers a variety of rights. The value of the share is the value of those rights. The main rights of a shareholder are:  to be paid dividends, if the company declares a dividend  to vote at general meetings, including elections of directors  to receive a share of the remaining assets of the company in the event of it being wound up Q; Who, then, owns a company? A: Technically, no-one: a company is a legal person. No-one owns persons For the sake of simplicity, (and in all text books) it is always stated that ordinary shareholders own the company that issues their shares  i.e. if you own 20% of the issued ordinary shares of Vodafone, you own 20% of the company

4. Ordinary shares Ordinary shares carry the full risk and reward of investing in a company. If a company does well, its shareholders will do well  At company general meetings, it is ordinary shareholders who vote “yes” or “no” to each resolution put forward by the company directors  The directors might propose to take over another company o If a majority of the shareholders do not think this is a good idea, the company cannot go ahead with the acquisition  Ordinary shareholders share in the profits of the company  They will receive a dividend each year, or sometime each half-year o The directors propose the dividend and the shareholders have to approve that proposal for the dividend to be paid  The amount of the dividend will depend on how well the company is doing o Some companies pay out a large proportion of their profits o Other companies will plough all profits back into future growth

5. Ordinary shares Ordinary shareholders suffer when company does badly  No dividends will be paid  Dividends can only be paid if there is sufficient profit (or retained profit) out of which to pay them  If the company closes down (“wound up”) the ordinary shareholders are paid out of the assets remaining after everybody else has been paid  If there is nothing left, the shareholders get nothing  If there is money left over after all creditors and preference shareholders have been reimbursed, it belongs to the ordinary shareholders

6. Preference shares Preference shares have the following characteristics:  Preference shares are usually non-voting  Unless in special circumstances, such as when the company has failed to pay their dividend  Preference shares pay a fixed dividend each year  The amount is set at the time when they are first issued  Preference shares rank ahead of ordinary shares in terms of being paid back, if the company is being wound up  Up to a limited amount

7. More on preference share dividends Preference shares can be non-cumulative, cumulative and / or participating Cumulative and non-cumulative  Suppose the company has had a bad year, and cannot afford to declare a dividend…  If the preference share is cumulative, the dividend entitlement would accumulate (mount up) until the company started paying dividends again  If the preference share is non-cumulative, the dividend is lost Participating  Participating preference shares are entitled to a basic dividend but also benefit if the company has a bumper year  When profit exceeds a certain pre-agreed level, the preference shares participate in the allocation of the financial surplus

8. Benefits of owning shares Shares carry risks: investors in shares require a reward for holding them. The reward is usually a financial return Dividends  Dividends are an annual (or semi-annual) payment to an investors for providing the risk capital for a business  Companies pay dividends out of the profits, which form part of their “distributable reserves”  Distributable reserves are the profits after tax, and after payment of dividends, which have been accumulated over the life of the company Companies try to achieve steady growth in their dividends. Investors might sell the shares if the dividend is cut sharply Remember: investors look at dividend yield: the dividend as a percentage of the current share price

9. Exercise Harris Plc has accumulated post-tax profits of £20m and paid out dividends totalling £13m  Distributable reserves are therefore £7m (£20m less £13m)  This year, Harris Plc has made a post-tax profit of £3m and decides to pay a dividend of £1m At the end of this year, distributable reserves are: Opening balance Profit after tax for the year Dividend Closing balance £m 7 3 ---- 10 (1) ---- 9 Although Harris only made £3m profit this year, it would be perfectly legal for it to pay out dividends totalling – say – £5m, because it has distributable reserves of 7m from earlier years. Dividends which have not be paid entirely out of the current year’s profits are known as “naked” or “uncovered” dividends.

10. Dividend payment history A company obviously cannot pay naked dividends forever, but it is worth doing for a year or two to keep shareholder loyalty  Shareholders will always compare the income from their shares (as measured by the dividend yield) with other potential investments  Other shares  Bonds  Cash deposits at the banks  Some companies have higher-than-average dividend yields  Perhaps the company is mature and continues to generate healthy levels of cash but has limited opportunities for expansion o Water and electricity supply companies (“utility” companies)have their prices regulated by the government  Demand for water and electricity grows at a steady but low rate  Perhaps the company’s share price is very low because the market thinks bad news is on the horizon o The dividend is high relative to the depressed share price o But the dividend is not expected to be sustained

11. Dividend payment history (cont.) Sometimes a company has a dividend yield which is relatively low:  Perhaps the share price has been pushed up to high levels, because speculators believe that good news is about to be announced  Or perhaps a large proportion of the profits has been ploughed back into the business, leaving little left over for dividends Ryanair has been very profitable for many years but has never paid a dividend. Only now that its meteoric expansion is showing signs of slowing down will the company start return cash to tis shareholders

12. Capital gains If a company like Ryanair pays no dividends, why has its share price gone up for much over the past 10 years?  Ryanair was a “growth” stock  Ryanair was expanding its operations across Europe o As its profits increased, investors bought the stock  in anticipation of more capital gains  in anticipation of future dividends (eventually!)  Or perhaps a large proportion of the profits has been ploughed back into the business, leaving little left over for dividends  Investors who bought the stock in 2004 had made a gain of 150% on their investment in 2½ years  This is called “capital gain”

13. Capital gains: realised and unrealised Capital gains are only banked, or “realised” if the shareholder sells the share for a profit.  Or perhaps a large proportion of the profits has been ploughed back into the business, leaving little left over for dividends If a shareholder bought Ryanair in mid-2004 and sold the stock at the end of Q1 2007, a capital gain of 150% would have been realised You have got to bank the money to realise a capital gain… But if the same shareholder held onto the share for another year, until 2008, all that profit would have been wiped out

14. Non-financial shareholder benefits Not all shareholder benefits are of a strictly financial nature: some companies offer perks to shareholders Although nice to have, very rarely as these of sufficient value to be a major factor in investment decisions… Based on July 2009 prices. Source: Which? Benefits can be withdrawn at any time. When Eurotunnel launched in the 1990s, investors with shares worth more than £5,250 were entitled to unlimited trips on Eurotunnel’s car-carrying shuttle for just £1 per trip. However, when the company refinanced in April 2007, shareholders were offered just six single trips a year at a 30% discount. After a shareholder revolt, investors were offered two alternatives – accept shares in the new company and lose the unlimited travel benefit, or keep the £1-a-trip perk and hold worthless shares in a dead company.

15. Bonus issues Sometimes companies give their shareholders extra shares without them having to subscribe any more capital A bonus issue is also known as a “scrip” or “capitalisation” issue. It is used to bring the down price of the share in the stock-market. A price which is too high can discourage some investors from buying. Most large UK companies try to keep their share price below £10 These are not “free” shares: the company simply takes some of its accumulated distributable earnings (which belong to the shareholders anyway) and converts them into shares  This is called “capitalising” earnings  The shareholders receive the bonus shares whether they want them or not  For this reason a bonus issue is one of the “mandatory corporate actions” that a company can take Example:  Harris Plc share price is £10 per share.  It has 5m shares in issue (par value £1).  It has accumulated distributable earnings of £9m  It capitalises £5m of these earnings by issuing one new share for each existing share (i.e 5m new shares  Share price is halved to £5 but share- holder has twice the number of shares

16. Bonus issues Some well known large companies have made bonus issues When tracking a company’s share price performance, it is important to adjust the historic share price for corporate actions, such as bonus issues. Otherwise a misleading picture could emerge.