LESSON 6: EQUITY SECURITIES MARKET

Learners should be able to:

1. Describe the different types of market capitalization;
2. Determine value of stocks based on the financial information made available
to them; and
3. Describe the rules and regulations applicable for a listed corporation.

EQUITY =ownership of a corporation

=Assets-Liabilities

OWNERSHIP = buying or investing into stock , one becomes part owner

or a shareholder of that particular corporation

Types of Stocks
1. Preference Shares- Treated as Quasi-debt
*Cumulative
*Callable
*Convertible

2. Ordinary Shares-True owners/ Residual owners

*Supervoting
*Nonvoting

EQUITY/STOCK MARKET =Place where shares/stocks are bought or

sold.

Why Invest in Equity Market? It offers the best chance in achieving

financial goals and gives the ability to later enjoy the benefits of the
money working for you.

The Four Golden Rules

1. Invest Early
2. Invest Regularly
3. Invest Long Term
4. Invest using Diversification

Face to Face Trading Online Trading

Different aspects of the financial markets:
1. Organized Exchanges: Organized exchanges are centralized platforms
where securities, such as stocks, bonds, commodities, and derivatives, are
bought and sold through a formalized trading process. These exchanges
provide a regulated marketplace with established rules, procedures, and
infrastructure for trading. Examples of organized exchanges include the
New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange
(LSE), and Tokyo Stock Exchange (TSE).

2. Over-the-Counter (OTC): Over-the-counter refers to the trading of

securities directly between parties, without the involvement of a
centralized exchange. OTC markets are decentralized and typically
involve transactions conducted through broker-dealers, electronic trading
platforms, or other intermediaries. OTC markets facilitate trading in
securities that are not listed on organized exchanges, including stocks of
smaller companies, corporate bonds, and certain derivatives.

3. Electronic Communications Network (ECN): An electronic

communications network is a type of trading platform that facilitates the
electronic execution of trades by connecting buyers and sellers directly.
ECNs operate electronically, matching buy and sell orders automatically
based on predetermined criteria such as price and quantity. ECNs are
commonly used for trading stocks and other financial instruments and are
known for providing efficient and transparent trading environments.

4. Exchange-Traded Funds (ETFs): Exchange-traded funds are investment

funds that are traded on organized exchanges, similar to individual stocks.
ETFs pool together assets such as stocks, bonds, or commodities and offer
investors exposure to a diversified portfolio of assets within a single
investment vehicle. ETFs trade throughout the day on exchanges like
stocks, allowing investors to buy and sell shares at market prices. ETFs
are popular for their liquidity, diversification, and potential tax efficiency.

Each of these terms represents a different facet of the financial markets,

offering investors various avenues for buying, selling, and trading securities
and investment products.
Philippine Stock Exchange (PSE) –a corporation that govern our local stock
market
Philippine Stock Exchange Index (PSEi) – point of reference

Equity instrument- type of instrument wherein the issuer agrees to pay an

amount to the investor in the future

METHODS OF EARNING IN EQUITY SECURITIES

1. Price Appreciation- increase in market price of your stock over time
brought by an increase in its potential value and the demand to buy its shares.
2. Dividends- whether in cash or in additional shares of stocks as a means for
shareholders to share in their distributed profits.

Rights vs Warrants
-Stock Rights- is a market offer, wherein a company need not go public to
raise further capital, instead it gives its current shareholders the right <not
obligation> to subscribe to newly issued shares in proportion to their existing
shares, usually at a discount to the market price.
Stock Warrants- gives the investor the right to purchase a company’s stock at
a specific price and on a specific date, however, once the time elapses it

becomes worthless
Market Capitalization – Total Market Value of all outstanding share of a
company (Market Price X Outstanding Shares)
- Benchmark the relative size of a company against another

Market Cap = Current Share Price * Total Number of Shares

Outstanding

Diluted Market Cap = Current Share Price * Total Number of Shares

Authorized

For example, consider Bitcoin trading at roughly P24,000 per coin as of

mid-August 2022. At the time of writing, there are also approximately
19.1 million Bitcoin issued. However, the total number of potential
Bitcoin that may eventually be minted is 21 million. Therefore,
Bitcoin's market cap calculations are:

Market Cap = P24,000 * 19.1 million = P458.4 billion

Diluted Market Cap = P24,000 * 21 million = P504 billion

Stock Valuation

Is the Market Price Reasonable?

Value of the Share = PV of the future Cash Flows (Discounted Cash

Flows approach)
*Projection

1. One-period or Multiple Period Valuation Model <Publicly listed

companies>

*If the investor’s purpose is to receive a greater return or dividend

during the holding period:
Where:
V0– the current fair value of a stock
Dn– the dividend payment in the nth period from now
Pn– the stock price in the nth period from now
r – the estimated cost of equity capital

Example: You are an investment analyst. Your client asked you to assess the
viability of the investment in ABC Corp. The client expects to hold the
investment for three years and sell it at the end of the holding period (end of
the third year). You’ve forecasted that ABC Corp. will pay dividends of P2.50 in
the first year, P3 in the second year, and P3.25 in the third year. You expect
that at the end of the third year, the selling price of the company’s stock will
be P125 per share. The estimated cost of capital is 5%. The current stock price
is P110 per share.

Po= (2.5 x 0.9524) + (3 x 0.9070) + ( 3.25 x 0.8638) + (125 x 0.8638)=

P115.88 intrinsic/true value of the company’s stock

Decision: The investor should consider buying this stock because

current selling price is lower than the True Value of the stock.

Dividend-based valuation techniques:

1. Zero Growth Dividend Discount Model (DDM)
The zero growth DDM assumes that all future dividends of a stock will be fixed
at essentially the same dollar value forever, or at least for as long as an
individual investor holds the shares of stock. In such a case, the stock’s
intrinsic value is determined by dividing the annual dividend amount by the
required rate of return:

Stock Value= Annual Dividends

Required Rate of Return
When examined closely, it can be seen that this is the exact same formula that
is used to calculate the present value of a perpetuity, which is

Present Value= Dividend

Discount Rate

For the purpose of using this formula in stock valuation, we can express this as

PV= D
r
where:
PV is equal to the price or value of the stock,
D represents the dividend payment, and
r represents the required rate of return.

This makes perfect sense because a stock that pays the exact same dividend
amount forever is no different from a perpetuity—a continuous, never-ending
annuity—and for this reason, the same formula can be used to price preferred
stock. The only factor that might alter the value of a stock based on the zero-
growth model would be a change in the required rate of return due to
fluctuations in perceived risk levels.

Example:

What is the intrinsic value of a stock that pays P2.00 in dividends every
year if the required rate of return on similar investments in the market
is 6%?

Solution:

Stock Value=P2.00/ 0.06=P 33.33

2. Constant-growth model or Gordon Growth Model <named after Myron

Gordon>
The most common DDM is the Gordon growth model, which uses the dividend
for the next year (D1), the required return (r), and the estimated future
dividend growth rate (g) to arrive at a final price or value of the stock. The
formula for the Gordon growth model is as follows:
 PV = D1
r−g
Where:
PV is equal to the price or value of the stock,
D represents the dividend payment, and
r represents the required rate of return
g represents the constant growth rate

LEGEND
T= TOTAL PERIOD MINUS 1
V FINAL= DIVIDEND AT YEAR N
V BEGIN= DIVIDEND AT YEAR 1

g= CAGR= Compounded Annual Growth Rate=

BOOK: 1.4^0.2= 1.06961037573 -1 X 100= 6.9610% OR 7%

or:

https://www.thecalculatorsite.com/finance/calculators/cagr-calculator.php

This calculation values the stock entirely on expected future dividends. You
can then compare the calculated price to the actual market price in order to
determine whether purchasing the stock at market will meet your
requirements.

Example:
Consider a company that pays a P5 dividend per share, requires a 10
percent rate of return from investors and is seeing its dividend grow at
a 5 percent rate.
A fair price, under this model, is P = 5/(0.10-0.05) = P100 per share.

Decision: At a higher price, investors won't get the desired rate of return, so
they'll sell the stock and lower the price. At a lower price it will be a bargain
since they'll get a higher rate than required, meaning other investors will bid
up the price.

3. Variable-growth model or Non-constant Growth Dividend Discount Model

Many experienced analysts prefer to use the variable (non-constant) growth
DDM because it is a much closer approximation of businesses’ actual dividend
payment policies, making it much closer to reality than other forms of DDM.
The variable growth model is based on the real-life assumption that a company
and its stock value will progress through different stages of growth.

The variable growth model is estimated by extending the constant growth

model to include a separate calculation for each growth period. Determine
present values for each of these periods, and then add them all together to
arrive at the intrinsic value of the stock. The variable growth model is more
involved than other DDM methods, but it is not overly complex and will often
provide a more realistic and accurate picture of a stock’s true value.

Example: Maddox Inc. paid P2.00 per share in common stock dividends last
year. The company’s policy is to increase its dividends at a rate of 5% for four
years, and then the growth rate will change to 3% per year from the fifth year
forward. What is the present value of the stock if the required rate of return is
8%?
Dividend PV PV
factor
Year 1 P2 x 1.05 2.10 0.9259 1.94439
Year 2 P2.1 x 1.05 2.205 0.8573 1.8903465
Year 3 P2.205 x 1.05 2.31525 0.7938 1.83784545
Year 4 P2.31525 x 2.4310125 0.7350 1.7867941875
1.05
Value after Year 4 50.0788575 0.7350 36.8079602625
P44.27
TV= Next dividend / Rate of return – growth rate= 2.43 x 1.03= 2.5029 / (8%-
3%)= 2.5/ 5%= 50.058 =2.503942875/5%= 50.0788575

2. Price Earnings (P/E) multiples <publicly and non-publicly listed companies>

The formula and calculation used for this process are as follows.

P/E Ratio = Market value per share

Earnings per share

It shows how much investors are willing to pay per peso of earnings

Example: If a company was currently trading at a P/E multiple of 20x, the

interpretation is that an investor is willing to pay P20 for P1 of current
earnings.

Optimizing Transaction Costs

Listed corporations in the Philippines are subject to various rules and
regulations to ensure transparency, fairness, and investor protection. Here are
some of the key regulations applicable to listed corporations in the Philippines:

1. Securities Regulation Code (SRC): The SRC is the primary law governing
the issuance, registration, and trading of securities in the Philippines. It sets
out the regulatory framework for listed corporations and regulates activities
such as public offerings, disclosure requirements, insider trading, and market
manipulation.

2. Philippine Stock Exchange (PSE) Rules: Listed corporations must

comply with the rules and regulations of the Philippine Stock Exchange, the
country's primary stock exchange. These rules cover areas such as corporate
governance, disclosure requirements, trading procedures, and delisting
criteria.

3. Corporate Governance Code: The Securities and Exchange Commission

(SEC) of the Philippines has issued a Corporate Governance Code for Publicly
Listed Companies, which provides guidelines for good corporate governance
practices. Listed corporations are expected to comply with the principles and
recommendations outlined in the code, which cover areas such as board
composition, shareholder rights, transparency, and accountability.

4. Disclosure Requirements: Listed corporations are required to disclose

information to the public in a timely and accurate manner. This includes
financial reports, material information, corporate developments, and
any other information that may affect the company's stock price or investors'
decisions.

5. Code of Corporate Governance: The SEC requires listed corporations to

adopt a Code of Corporate Governance, which sets out the company's policies
and practices related to governance, risk management, and compliance.
The code should be aligned with the SEC's Corporate Governance Code and
should be disclosed to shareholders and the public.

6. Insider Trading and Market Abuse Regulations: The Philippines has

laws and regulations prohibiting insider trading and market abuse. Listed
corporations and their insiders are prohibited from trading securities based on
material non-public information, and the SEC enforces rules to prevent market
manipulation and other fraudulent activities.

7. Annual General Meeting (AGM) Requirements: Listed corporations are

required to hold an annual general meeting of shareholders, where important
matters such as the election of directors, approval of financial
statements, and other corporate resolutions are discussed and voted upon.

8. Regulatory Oversight: The SEC is the primary regulatory authority

overseeing listed corporations in the Philippines. The SEC has the authority to
enforce securities laws and regulations, conduct investigations, impose
sanctions for non-compliance, and oversee the operation of the Philippine
Stock Exchange.

9. Other Applicable Laws: In addition to securities laws and regulations,

listed corporations in the Philippines must also comply with other relevant
laws and regulations, including corporate law, tax law, accounting standards,
and labor laws.

It's important for listed corporations in the Philippines to stay informed about
the latest regulatory developments and ensure compliance with applicable
laws and regulations to maintain the trust of investors and regulators.
 ASSIGNMENT= Pages 173-178 &

STOCK EQUITY MARKET ASSIGNMENT

AAA has a beta of 1.10. The risk-free rate of interest is currently 6%, and the
required return on the market portfolio is 13%. The company plans to pay a
dividend of P2.91 in the coming year and anticipates that its future dividends
will increase at an annual rate consistent with that of the 2022–2024 period:

Year 2022 2023 2024

Dividend 2.25 2.45 2.67

1. Determine the dividends growth rate. ________________

2. Estimate the value of AAA’s stock. _______________

3. BB’s stock is currently selling for P160.00 per share and the firm’s dividends
are expected to grow at 5 percent indefinitely. In addition, its most recent
dividend was P5.50. If the expected risk free rate of return is 3 percent, the
expected market premium is 5 percent, and it has a beta of 1.2, BBB’s stock
would be _________.
a. overvalued
b. undervalued
c. properly valued
d. Not enough information to tell

4. DDD has common stock with a market price of P25 per share and an
expected dividend of P2 per share at the end of the coming year. The growth
rate in dividends has been 5 percent. The cost of DDD’s common stock equity
is ______________

5. EEE has common stock with a market price of P55 per share and an
expected dividend of P2.81 per share at the end of the coming year. The
dividends paid on the outstanding stock over the past five years are as follows:

Year 1 2 3 4 5
Dividend 2.00 2.14 2.29 2.45 2.62
The cost of the firm’s common stock equity is ___________________

6. FFF has common stock with a market price of P100 per share and an
expected dividend of P5.61 per share at the end of the coming year. A new
issue of stock is expected to be sold for P98, with P2 per share representing
the underpricing necessary in the competitive capital market. Flotation costs
are expected to total P1 per share. The dividends paid on the outstanding
stock over the past five years are as follows:

Year 1 2 3 4 5
Dividend 4.00 4.28 4.58 4.90 5.24
The cost of this new issue of common stock is ___________

7. The COLLECTOR has agreed to sell the reality stone to GGG in three years
at a price of P100,000. The current risk free rate is 7 percent. At what price
should she value her collection today? _________

8. Asset P has a beta of 0.9. The risk free rate of return is 8 percent, while the
return on the market portfolio of assets is 14 percent. The asset’s required
rate of return is _________________

9. What is the expected market return if the expected return on asset X is 20

percent, its beta is 1.5, and the risk free rate is 5 percent? ________________

10. What is the expected risk-free rate of return if asset X, with a beta of 1.5,
has an expected return of 20 percent, and the expected market return is 15
percent? _____________

11. A firm has determined its cost of each source of capital and optimal capital
structure, which is composed of the following sources and target market value
proportions:

Source of Capital Target Market Proportions After-Tax Cost

Long-term debt 40% 6%
Preferred stock 10 11
Common stock equity 50 15
The weighted average cost of capital is _________________

12. Preferred stock is valued as if it were a

a. fixed-income obligation.
b. bond.
c. perpetuity.
d. common stock.

13. The cost of preferred stock is

a. lower than the cost of long term debt.
b. higher than the cost of common stock.
c. higher than the cost of long term debt and lower than the cost of common
stock.
d. lower than the cost of convertible long term debt and higher than the
cost of common stock.

14. The disadvantages of issuing common stock versus long term debt include
all of the following EXCEPT
a. the potential dilution of earnings.
b. high cost.
c. no maturity date.
d. the market perception that management thinks the firm is over valued,
causing a decline in stock price.

15. Horizon Corp. reported total assets of Php1,750,000 financed by 70%

liabilities. It is further noted that their retained earnings is Php400,000. The
outstanding shares of Horizon is 40,000. If the value of the stocks of Horizon in
the market is 1.75x of the value issued to the primary market, the value of the
Horizon prevailing in the secondary market is _____.

16. A 5% preferred stock with a par value of Php100 was offered in the market.
The dividends are to be paid annually. If the required return is 16%, the value
of the preferred stock would be _______.

17. A firm recently paid dividends amounting to Php5.36 per share. Four years
ago they’ve declared Php4.50 per share. The growth is found to be constant. If
the required return is 15%, the value of the stock is _________
18. A stock with a beta of 1.45, risk free rate is an annual rate of 5% and the
market return is quoted at an annual rate of 11%. The stock committed to
declare a regular dividends of Php5.20 per share. In 2020, a global pandemic
affected the operations of the company that increased its beta to 1.75. The new
equilibrium price of the stock based on the recent events will be _____

19. An investor is planning to purchase a stock of Prime Corp. The dividends

per share of Prime Corp is expected to be: Year 1 – Php10; Year 2 – Php12;
Year 3 – Php13. The investor also planned to sell it out after 3 years at Php150
per share. Suppose that the required return is 15%, the value of the stock
today is _______

20. An investment proposal that paid dividends amounting to Php12 per share
and will grow 17% per year. If the required return is 15%, the value of the
stock a year after is _________.

21. DDD has an outstanding preferred issue of stock with a par value of P100
and an annual dividend of 12% (of par). Similar-risk preferred stocks are
yielding a 14% semiannual rate of return. What is the current value of the
outstanding preferred stock? _____________

22. ABC is looking for an investment from ZZZ Inc, a publicly listed company.
Based on available dividend information for the last 5 years:

Year Dividend per

share
1 P5
2 5.5
3 5.9
4 6.4
5 7.1

Compute the compound annual growth rate ___________