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Karlsruhe -Liverpool Exchange

November 2003

Investing in Shares for Fun & Profit

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The Hope Sessions

The project sessions led by Liverpool Hope Staff will be concerned with shares, share investment and the management of share portfolios.• Part A consists of devising a share portfolio to match

a given description on a simulated Stock Exchange.• Part B consists of managing a £100,000 share

portfolio over a three month period• Part C consists of devising an investment decision

tool to help in managing portfolios

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Purpose of the Session

This session provides an introduction to Part B of the the project, discussing some of the background, and ensuring that you have enough understanding of the concepts and terms used in the activity sheets which follow.

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Session Content

In this session we will cover:1. Investing in Shares – some further

details.2. The Stock Exchange – rules &

procedures3. Investing for Profit4. Measuring share performance.5. Investing for Fun.

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Part 1

Investing in Shares

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Types of Shares

There are two different types of share that we need to consider:

Ordinary Shares All companies issue these type of shares. The total of the amount invested in these is normally

referred to as the equity of the company.

Preference Shares These shares guarantee that if a dividend is paid,

preference shareholders get the first part of it.

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Ordinary Shares: Technical Details

The money invested is not refundable (normally) unless organisation wound up. There is no security.

Issued Share Capital = amount actually issued Authorised Share Capital = Amount which can be issued Shares may be sold to another party but are not

redeemable (cannot be sold back to the company) Shareholders are rewarded by dividends and the increasing

value of their shares Normally each ordinary share carries one vote Shareholder rights are explained within the Memorandum &

Articles of Association

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Preference Shares: Technical Details

Preference shareholders are entitled to the first part of dividend payments (up to a maximum value)

e.g. 10,000 preference shares, value £1 at rate of 6% - first £600 of dividends goes to preference shareholders

Forms include: cumulative preference shares (which accumulate if a dividend is missed one year); convertible preference shares and redeemable preference shares

These shares do not normally carry voting rights

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Ordinary Shares

• For simplicity, we will restrict all our dealings to ordinary shares in companies quoted on the London Stock Exchange

• You will have £100,000 of virtual money to invest in these companies

• Your task is to return as big a profit as you can.

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Dividends and Profit

• The dividend is the shareholder’s portion of the company’s profits.

• If the company is profitable, then the dividend will be high (5-10%) and as a result the price of the share will probably rise, increasing the value of the investment; The investor can often gain twice.

• If the company is not profitable then there may be no dividend, and the share price will drop.

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Not available for dividend

Share capital (at normal or

par value)

Capital reserves

Revenue reserves

Available for dividend

Availability for dividends of various parts

of the shareholders’ claim

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Shareholders Funds

Most permanent form of funding. Classed as “Liability” Issued Share Capital - value of shares actually issued Authorised Share Capital - value of shares company

may legally issue Retained Profit (or Earned Surplus) - profit left after all

deductions have been made Capital Surplus - money earned on disposal of Fixed

Assets Capital Employed - all the capital put into the business

(share capital, long-term loans, retained profit)

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Part 2

The Stock Exchange:

Rules & Procedures

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Trading Shares on the Stock Exchange

The London Stock Exchange is in Throgmorton Street, within walking distance of the Bank of England. (“The City”)

There are two types of trading: A broker buys and sells shares on behalf of the general

public A dealer (or jobber)is a wholesaler of stocks and shares, and

very often a specialist in certain types of share

Since 1986, the dividing line between brokers and dealers has become blurred

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Accounting Rules

There are three distinct Sources of Accounting Rules for companies listed on the Stock Exchange:

1. Company Law

2. Accounting Standards

3. Stock Exchange Rules

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Company law

Accounting standards

External accounting

rules

Stock exchange rules

Sources of accounting regulations for a UK limited company listed on the Stock Exchange

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Company Law

Company Law as embodied in the Companies Acts 1985 & 1989 requires that Directors are responsible and accountable for their actions in respect of their management of the company’s assets:

1. To maintain appropriate accounting records2. To prepare an annual profit & loss account, a

balance sheet that shows a true and fair* view of accounts as well as a Directors’ Report and to make these available to all shareholders and the public at large.

*The term “true & fair” is not clearly defined in the legislation

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Stock Exchange Rules

• These rules extend the accounting rules for those companies listed on the Stock Exchange.

• These rules require:• Summarised interim (I.e. half-yearly) accounts in

addition to the annual accounts.• A geographical analysis of turnover• Details of shareholdings in other companies where

the investment is greater than 20%

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Accounting Standards

• Shareholders are required to elect a qualified independent person to act as Auditor.

• The role of this person (or firm) is to report on whether or not the company’s financial statements are “true and fair”, and whether they comply with the regulatory frameworks.

• In order to do this, auditors must not only scrutinise the statements, but the evidence on which the statements are based.

• Their report is sent to the Registrar of Companies.

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Shareholders

elect

account

review

Directors

Auditors

elect

The relationship between the shareholders, the directors and the auditors

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Trading Shares on the Stock Exchange

A broker charges a specific charge for buying or selling shares. This might be a percentage, or a fixed fee. Traditionally the broker will deal with the jobber or dealer (However, the jobber might be another person employed by the same stock broking firm).

A jobber makes money by buying at a specific low price (“bid” price), and selling at a higher price (“offer” price).

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Trading Shares on the Stock Exchange: An Example

An investor might wish to sell 500 shares in HBOS; the broker may charge a flat fee of £15, and contact a dealer (jobber) who will quote a bid price of £7.80 per share.The investor will get £3,875 for their shares

On the other hand, an investor who wishes to purchase 500 shares in HBOS might be charged £15 by the broker, and the dealer will quote an offer price of £8.10 per share The cost to the investor will be £4,065

In these transactions, the broker makes £30 and the dealer makes £150

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Part 3

Investing for Profit

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Investing for Profit

• In addition to the dividend, Investors are looking to make money when the price of shares increases (and decreases)

• As the price of shares decreases, investors will be more likely to buy in the hope of getting a bargain.

• As the price of shares increases, investors are more likely to sell and ‘profit take’.

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Return on Investment

• One way of measuring the profitability of shares is to use the percentage Return on Investment (%ROI)

• %ROI = increase in value x 100%purchase price

• Suppose shares in Sheer Fiction PLC are bought for £1.60 and is sold for £2.00.

• The shares have made 40p profit. • This is a Return on Investment of:

0.40 x 100 = 25% 1.60

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Risk and Uncertainty

It is suggested that when investing your £100,000 you use a combination of the following methods to cope with uncertainty:• Trying to read market trends; spotting a bargain; buying

cheap and selling at a profit when the price has risen.• Keeping abreast of events; takeovers, profitability

forecasts; social changes.• Create a portfolio of shares of different types to balance

risk (as in Unit Trusts)• Using statistics to attempt to predict trends and

movements

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Balancing a Portfolio

• In the real world of investment, many of the major players are pension funds and banking corporations

• The following slides show how the 3i organisation with a capital investment of nearly £4 Billion balanced its portfolio in 1997

• You will notice that the portfolio consisted of a range of investments and not just shares. In fact the listed shares only formed a minor part of the portfolio.

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3i Investment portfolio 1997Portfolio value by investment instrument

583.4

1,703.3

3,795.5

808.5

700.3

£m

Equity shares – listed*

Equity shares - unlisted

Fixed income shares

Loans

Total

* Shares which are listed on a recognised stock exchange

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3i Investment Portfolio value by sales revenue of investee businesses

163.1

448.1

783.0

483.1

865.4

446.3

329.5

277.0

£m

Up to £1m

£1m - £5m

£5m - £10m

£10m - £30m

£30m - £50m

Greater than £50m

Recent investments

Loan only investments

Total 3,795.5

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3i Investment portfolio 1997Portfolio value by size of investment

106.0

555.0

1,502.5

996.4

635.6

£m

Up to £250k

£250k - £1m

£1m - £2m

£2m - £5m

Over £5m

3,795.5Total

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Part 4

Measuring Share Performance

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The Use of Statistics

• Shares values can fluctuate greatly over a period of time, and unless a sale is imminent, the market share price at a particular moment in time may not be all that helpful in working out a long-term investment strategy.

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The Use of Statistics

• Data is usually collected on the long term behaviour of shares, and statistical analysis used to determine trends and summary figures.

• Some of these are:• Averages• Measures of Variability• Trend Analysis• Performance measures

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Average Share Values

There are many interpretations of this:• The arithmetical mean of the opening and closing stock

value on a particular day• The mean value over a year (hourly, daily, weekly,

monthly)• The weighted average shares sold on a particular day

NB In this project, it will be useful to know the average value over a year, taken on the share prices at the end of each day or each week

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Average Share Values

• During weeks 1-20, the average value of E-cost shares is £60.70, and the average value of Girvin shares is £16.41

• The share prices at the beginning of the investment period were £60.01 (E-cost) and £15.98 (Girvin).

• On this basis Girvin (2.69%) is outperforming E-cost (1.15%) – average %ROI

SHARE E-cost Girvin

But at: £60.01 £15.98

WEEK

1 £66.85 £16.442 £63.08 £16.453 £62.08 £16.354 £57.64 £16.775 £60.34 £16.616 £62.12 £16.447 £62.44 £16.878 £66.10 £16.769 £58.41 £16.68

10 £59.19 £16.5011 £53.01 £16.1112 £50.35 £15.9413 £53.07 £16.2414 £56.37 £16.3715 £66.61 £16.1716 £63.23 £16.4517 £65.02 £15.8118 £69.50 £16.1119 £58.04 £16.3320 £60.56 £16.75

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Measuring Variability

• Graphing the day-to-day fluctuations of the share value can give you a visual feel for the way that the value of a stock changes.

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Measuring Variability

Methods Include:• The Range of values (high and low values taken over the

day, month or year)• The Standard Deviation of the share price taken over a

period of time.• The Percentage Variation is a ratio of the standard

deviation to the mean expressed as a percentage.

NB In this project, it will be useful to know both the high and low values during the year, and the standard deviation calculated over the year.

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Measuring Variability

The Range of values E-cost : £9.28 to £41.98Girvin: £10.78 to £14.34

The Standard Deviation:E-Cost: £7.93Girvin: £0.94

The Percentage Variation:E-cost: 37.05%Girvin: 8.04%

SHARE E-cost Girvin

But at: £60.03 £15.94

WEEK

1 £41.98 £14.342 £36.80 £13.673 £21.81 £13.024 £18.13 £12.335 £18.25 £11.706 £23.81 £11.287 £27.03 £11.578 £21.52 £11.109 £16.92 £10.88

10 £18.55 £11.5211 £14.93 £11.3612 £9.20 £11.5613 £20.36 £11.9114 £14.03 £11.7015 £10.59 £11.3716 £17.21 £11.0717 £22.16 £11.4818 £21.89 £10.9519 £29.26 £10.9820 £23.63 £10.78

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What do the variability figures tell us?

• The range of values tells us the high and low points of the period under examination.

• The standard deviation tells us how much above or below the mean we can expect the shares to vary on a week-by-week basis

• The percentage variation tells us the proportion of the value that we can expect to lose or gain

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Trend lines and Regression Analysis

• A trend line is on a graph attempts to ‘smooth out’ all the fluctuations and variations in order to be able to see the general direction of movement.

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The dotted line is the trend line

The dotted line is the trend line

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Trend lines and Regression Analysis

There are many different types of trend line:• A Moving Average will take the arithmetic mean of the last

few items• A Linear Approximation will attempt to find the best straight

line fit to the points. • A Polynomial Approximation will attempt to find a best fit

which has a specific number of ‘highs’ and ‘lows’• Exponential and Logarithmic Approximations use more

mathematical criteriaNB In this project, it would be sensible to use a Moving Average

of say 4 weeks (monthly average) or a polynomial approximation of degree 4 over the year (seasonal variation).

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Different Trend lines

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Moving average trend line (4 points)

Moving average trend line (4 points)

Polynomial trend line (degree 4)

Polynomial trend line (degree 4)