Topic 6 : Equity Markets

Malaysian Equities (Module 7)

Topic Objectives

• Discuss the importance and structure of Malaysian equity

markets
• Relate the concept of shares and the various equity hybrids
• Discuss the various share issues and its impact on market price
• Describe the role of valuation and its myths
• Apply the various approaches to valuation of equities
• Relate the importance of valuation in context and criticisms on
valuation

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 Equity Markets

Malaysian Equity Markets

Introduction

Fund rising through equity ownership – the money paid to own the shares becomes the capital of the company and
the shareholders are the owners of the company

Stock market – bridges the gap between borrowers and investors i.e. facilitating the flow of funds

Stock
Increasing the quantity of
funds available to the market : Directing the flow of new
finance industry Basic savings
functions

Bursa Malaysia Securities Berhad

Main Market ACE Market

For established companies with track record Growth platform for companies

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 Equity Markets

Shares

Required Return by Shareholders

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 Equity Markets

Shares

Risk-return Characteristics
Total required
Rate of return

Derivatives

Ordinary shares
Corporate bonds

Risk-free rate Treasury bills

of return

No or Low Risk Medium Risk High Risk

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 Equity Markets

Shares

Share Ownership

Advantages Disadvantages

Limited right to inspect company’s book

Bear all risk of company
Right to dividends and capital gains
Only receive dividend if profitable
Right to sell shares to anyone
Paid out last in the event of liquidation
Pre-emptive rights
Only receive dividend when declared by
Right to vote at AGM
BOD
Right to control company

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 Equity Markets

Changes in Number of Shares Issued: Right Issue

Right Issue

Why? How?
Raising capital for Exercise some or all
What? expansion or loan rights
Privilege granted to repayment
Sell some or all rights
shareholders to acquire Giving existing
additional shares directly Buy additional rights for
shareholders
from issuing company trading or exercise
opportunity to acquire
additional shares at Do nothing and let rights
discount expire

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 Equity Markets

Changes in Number of Shares Issued: Right Issue

1. Theoretical ex-rights price: reference price at which the shares will be traded ex-rights.

Example: Propose rights issue on the basis of one for two existing shares of Rm1 each at an issue price of RM1.50 per ordinary
share. The current market price is RM3 per share.

Ex-rights price = (2 x RM3) + (1 x RM1.50)

No of existing shares + No of rights
required for rights entitled
= RM2.50

2. Intrinsic value of rights: reference price at which the rights will be traded during the rights trading period.

Example: as above.

Intrinsic value of rights = Ex-rights price – Rights issue subscription price

= RM2.50 – RM1.50
= RM1

3. Date of trading of rights: second market day after the despatch of PLO or PAL pertaining to the right issue.

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 Equity Markets

Changes in Number of Shares Issued: Retention Money

Retention money: amount to be deducted from the transacted value to protect buyer’s interest

1. Bonus issue – Example: Bonus issue of 1 for 2. Original holding (O) = 2, Bonus (B) = 1
Deduction ratio = B = 1 =1
O+B 2+1 3
Selling broker will deduct 1/3, buying broker 33.33% and between broker 1/3 of contract price.

2. Right issue – Example: Rights issue of 1 for 2. Original holding (O) = 2, Rights (R) = 1
Deduction ratio = R = 1 =1
O+R 2+1 3
Selling broker will deduct 1/3, buying broker 10% and between broker 1/3 of contract price.

3. Bonus entitled to rights/ Rights entitled to bonus –

Example: Bonus 1 for 4. Rights 1 for 1. Original holding (O) = 4, Bonus (B) = 1, Rights (R) = 5 (4 rights from O and 1 rights from
B) / Rights 1 for 4. Bonus 1 for 1. Original holding (O) = 4, Rights (R) = 1, Bonus (B) = 5 (4 rights from O and 1 rights from B)
Deduction ratio = B+R = 1+5 = 3 / Deduction ratio = B+R = 1+5 =3
O+B+R 4+1+5 5 O+B+R 4+1+5
Selling broker will deduct 3/5, buying broker (10% + 1/10) 20% and between broker 3/5 of contract pri ce /
Selling broker will deduct 3/5, buying broker (10% + 5/10) 60% and between broker 3/5 of contract price

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 Equity Markets

Changes in Number of Shares Issued: Retention Money (cont.)

4. Rights issue and bonus issue taking place simultaneously but each not entitled to the other:

Example:
Rights of 1 for 2, Bonus of 1 for 4
Method 1 Method 2

Assume original holding (O) = 2 Assume original holding (O) = 4

Rights (R) = 1 Rights (R) = 2
Bonus (B) = ½ Bonus (B) = 1

Deduction ratio Deduction ratio

= R+B = R+B
O+R+B O+R+B
= 1 + 0.5 = 2+1
2 + 1 + 0.5 4+2+1
=3 =3
7 7

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 Equity Markets

Changes in Number of Shares Issued: Bonus Issue

1. Does not result in company raising new finance.

2. Capitalisation of accumulated reserves, bring nominal capital in line with the value of capital used.
3. Once money is transferred from capital reserves to issued share capital account, it cannot be paid out a a
dividend.
4. Theoretical ex-bonus price – Example: scenario of a 3:1 bonus, market price = RM4 prior to the issue

Theoretical ex-bonus price = Market price x Original number of shares

New number of shares
= RM4 x 50,000
200,000
= RM1

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 Equity Markets

Equity Hybrids

Preference Share and Convertible Unsecured Loan Stock

Preference shares – cumulative, non-cumulative, participating, redeemable, callable, convertible, PIK preferred stock.

Convertible Unsecured Loan Stock (CULS) – more saleable because of conversion privilege
Example: Market price = RM5, convertible basis = 2 CULS at nominal value of RM1 for 1 new ordinary share of RM1
each.
Intrinsic value of CULS = Market price of ordinary shares
Number of CULS required for conversion
= RM5 = RM2.50
2

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 Equity Markets

Equity Hybrids

Warrants

Warrants – right to buy specified number of shares at a stated price within a specified time period.

Intrinsic value of warrant = (Market price of share – Exercise price) x (Number of shares each warrant
entitles the holder to purchase)
Warrant premium = Market price of warrant – Intrinsic value of warrant

Features of a Call Warrant

Underlying asset Exercise price Exercise period

American (exercise at
Issued on the any time up to/on
Price is fixed at the time No value after expiry
underlying maturity date),
of warrant issuance date
asset/security European (exercise on
maturity date)

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 Equity Markets

Equity Hybrids

Theoretical Ex-entitlement Price

Example: ABC Bhd announcement:

1. Bonus issue of 24,640,000 new ordinary shares of RM1 each on the basis of 2 new shares for every 5 existing shares.
2. Right issue of 36,960,000 new ordinary shares of RM1 each at issue price of RM3.20 per share on the basis of 3 new shares for
every 5 existing shares.
3. Right issue of 123,200,000 nominal amount of 3% bank guaranteed redeemable unsecured loan stocks 20x1/20x5 (RULS) with
49,280,000 detachable warrants issued at 100% nominal on the basis of RM10 nominal amount of RULS and 4 warrants for every
5 existing shares held.

The bonus and rights issues are not entitled to each other. The cum-all price is assumed to be RM12.30 per share.

1. Theoretical ex-all price = (5 x RM12.30) + (3 x RM3.20) = RM7.11

5 + 3 (Rights) + 2 (Bonus)

2. Intrinsic value of rights entitlement to share = Ex-all price – Rights subscription price
= RM7.11 – RM3.20
= RM3.91
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 Equity Markets

Equity Hybrids

Theoretical Ex-entitlement Price (cont.)

3. Assuming exercise price is RM3 on the basis of 1 warrant for 1 new share,
Intrinsic value of warrant = (Ex-all price – Exercise price) x (Number of shares each warrant entitles the holders
to purchase)
= (RM7.11 – RM3) x 1
= RM4.11

4. Assuming exercise price is RM3 on the basis of 1 warrant for 1 new share and offer price for each warrant is
RM0.50 per warrant,
Intrinsic value of warrant rights = Ex-all price – Exercise price – Offer price
= RM7.11 – RM3 – RM0.50
= RM3.61

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 Equity Markets

Equity Hybrids

Theoretical Ex-entitlement Price (cont.)

5. Retention money:
Deduction ratio for buying broker and client = 2 (B) + 10% (R) + 10% (RULS) = 30%
20

Deduction ratio for selling broker and client = 2 (B) + 3 (R) + 10 (RULS) = 3 or 75%
20 20 20 4

Deduction ratio between broker to broker = 2 (B) + 3 (R) + 10 (RULS) = 3 or 75%

20 20 20 4

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 Equity Markets

Classification of Shares for Investment Purposes

• Shares of major companies with long and unbroken records of high

Blue Chips earnings and good dividends

• Shares of companies whose sales and earnings are currently growing

Growth Shares faster than the economy and industry

• Companies whose earnings track the business cycle i.e. economic

Cyclical Shares conditions improve, earnings and share price rise and vice versa

• When the shareholders wish to live off current income from the
Income Shares investment

• Shares of companies whose future earnings are likely to withstand

Defensive Shares economic downturn with relatively moderate/low business and financial
risk

Speculative Shares • Has high probability of low/negative return which lead to overpriced

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 Equity Markets

The Role of Valuation

From individual investor point of view – in deciding to buy

security
Reasons for valuation

In the context of portfolio management – in deciding investment

with optimum required rates of return

In the context of company restructuring, take-over/merger

exercise, divestment

In term of company performance – allow assessment for

continued profitability (product launching, new market entries,
joint ventures)

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 Equity Markets

The Valuation of Equities

Basic Approaches

Fundamental analysis Technical analysis

Involves
Assumption: Any Assumption:
charts,
profitability Concerns mispricing sentiment/ Concerns Trends/
graphs,
Question of will with will be mood of with patterns
statistical
profitability determine intrinsic/tru corrected by investors perceived repeat
data to
the share e value the market drives share value themselves
predict
price takes in the future prices
share price

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 Equity Markets

The Valuation of Equities

Valuation models Discounted Cash Flow Method DCF Model

Capital Asset Pricing Model
Weighted Average Cost of Capital
Dividend Discount Model
Constant Growth Dividend Model
The Gordon Growth Model
Two-stage dividend Discount Model

Comparative Methods Price Earnings Ratio (PER)

Price-to-book Value Ratio

Asset Basis Valuation Book Value or Adjusted Book Value

Replacement Value

Liquidation Value

Break-up Value

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 Equity Markets

Valuation of Equities

Discounted Cash Flow Method

1. DCF model:

2. Cost of capital using capital asset pricing model (CAPM):

Required rate of return = Interest rate on risk-free securities + Market beta [Average
return on the market portfolio – Interest rate of risk-free securities]

3. Overall company cost of capital using concept of weighted average cost of capital (WACC):
WACC = [After tax cost of debt x Proportion of debt financing] + [Cost of equity x Proportion of
equity financing]

4. Dividend discount model:

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 Equity Markets

Valuation of Equities

Discounted Cash Flow Method (cont.)

5. Constant growth dividend model:

6. Gordon growth model:

7. Two-stage dividend discount model:

where the terminal price:

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 Equity Markets

Valuation of Equities

Discounted Cash Flow Method (cont.)

8. Present value of operating cash flows:

9. Present value of free cash flows:

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 Equity Markets

Valuation of Equities

Comparative Method

1. Price earnings ratio:

Earnings per share (EPS) = Profit attributable to equity shareholder
Number of ordinary shares

Price earnings ratio (PER) = Market price per share

Earnings per share

Earnings yield = EPS = 1

Market price PER

Problems – PER should be seen as tied to company business cycle, limitations of EPS reflected
in PER, dilutive issues, limitations of EPS reflected in Earnings Yield
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 Equity Markets

Valuation of Equities

Comparative Method (cont.)

2. Price-to-book value ratio:

Book value per share = Book value of assets – Book value of liabilities
Number of ordinary shares

Price-to-book value ratio (PBVR) = Market price per share

Book value per share

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 Equity Markets

Valuation of Equities: Limitations of Comparative Methods

Use of conventional accounting information

Lack of specific information

Analysis of consolidated financial statements of a group of companies poses problems

The timing of financial reports

Different financial year end of different companies complicates comparisons

Lack of benchmark ratios for evaluation purposes

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 Equity Markets

Valuation of Equities

Asset Basis Valuation

Book value or adjusted book value – assets minus liabilities

Replacement value – value business from the perspective of current replacement cost of assets

Liquidation value – what individual asset would be worth at auction or liquidation

Break-up value – assumes a company is worth more broken into portions and sold separately
than as a whole

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 Equity Markets

Factors Affecting Valuation

Estimation of growth
rate

Stocks in the Estimation of discount

benchmark index rate

Stock liquidity and

Estimation of cash flows
freefloat

Earnings quality

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 Equity Markets

Related Issues

Equity
Sensitivity Valuation
Analysis not done
in Isolation

Criticism of
Valuation
Myths
Approache
s

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