Busting Financial Jargon – Shares, IPOs, and things
So you saw the Jumia IPO (Initial Public Offering) on the 6 August 2019. (Jumia, for those who don’t know, is a large African Online store/vendor). Perhaps you’ve read about the 75% surge in price on the day. You are dying to get involved in the stock market but have no idea where to start. The good news is, it’s not that complicated. In this article we explain some of the common jargon around shares and shareholding in publicly traded companies.
Stockmarket – Origins
The stock-market has existed in some shape or form since the 17th century when the Dutch East India Company sought to raise capital for its voyages across the world. It did so by issuing shares to common folk in the Netherlands. Today, the VOC (“Vereenigde Oranje Companje” or “Dutch East India Company”) is no more (and good riddance to it) but the idea has pretty much stuck.
How it works
At first, a listed company will offer its shares to the public during an IPO process. A sponsor (usually an investment bank), the exchange the company plans to list on as well as an auditor supports the process. Members of the public/banks/asset managers can apply for an allocation (number of shares) via their stockbroking account. This initial period, or “Primary market”, is when a company sells shares to the public directly. Once a stock has listed, the public can then trade amongst each other (via their brokers of course) – the Secondary market. This is what you and I see on TV.
The aim of the listing company is to get the public to buy up all of the stock they are offering (known as the issued capital). When this occurs the IPO is said to be fully subscribed. If the public is not willing to purchase all of the shares on offer (all of the issued capital), the IPO is said to be undersubscribed, and usually trades at less than the IPO price from day one onwards.
Shares and shareholding
Each Shareholder has a right to vote at the company’s Annual General Meeting. Holders of ordinary shares are usually entitled to one vote per share held. Certain key investors (usually founding members) sometimes own special classes of shares (called “A-Shares”) which give them a larger proportion of the voting rights. For Example, Johannesburg listed Media and Tech Company Naspers, has A and N-classed shares. A class shares have 1000 votes per share, whereas N-class shareholders have 1 vote per share.
What’s in it for Risk-takers?
What compensation do equity investors (shareholders) enjoy for the risk they are taking? Compensation for the investor takes the form of dividends. Dividends are a portion of the profits of a company which it disperses to its owners periodically (usually annually). The payment of dividends is usually a good indicator of 1. That the company is a going concern. 2. What the share is realistically worth (intrinsic value). Note: Dividends are usually DISCRETIONARY. A company may choose to issue no dividend at any point in time. It is also possible to have a guaranteed dividend, but more on that later.
Dividing the share price by the latest dividend per share, gives you a quick way of determining whether a stock is overvalued or undervalued. The result of this calculation is known as the Price-to-earnings ratio (PE ratio).
Dividends & PE Calculations
Looking at the example below Limuru Tea, Williamson Tea and Kapchorua Tea are all Kenyan Tea growing companies. Limuru Tea (LIMT) has a share price of Ksh 460 per share but pays Ksh 1.10 in dividends. The PE Ratio of LIMT is therefore 418.18. Compared to that of Williamson Tea (WTK) P/E 14.27 and Kapchorua Tea (KAPC) P/E 4.79, Limuru Tea is vastly more expensive and Kapchorua is the cheapest.
Sometimes the same company will offer different dividends to different shareholders. This stock offered with a better and more consistent dividend are known as “Preferred Shares” (“Pref Shares”). These Pref Shares usually have a fixed dividend Percentage (dividend rate) and are more senior (higher up the pecking order) than ordinary shares e.g Kenya Power Pref Shares have a fixed dividend of 4%. In other words, when liquidating a listed company, Preference shareholders will be compensated from the proceeds of the liquidation, ahead of ordinary shareholders.
Common Tricks
During the lifespan of a company’s listing, management has a few tricks up their sleeves to maintain the valuation.
If executives believe the share price is too high, the company can offer further shares to existing shareholders. This is a rights offer. Existing shareholders are given first option (rights) to buy the new shares at a price below what the share is currently trading at. This declaration of rights (a “Nil Paid Letter”) is also tradeable (it represents the right to buy a share at a discount) UNTIL the new issue of additional shares takes place. When this takes place, every existing shareholder holds a smaller portion of the total issued shares. This rights issue is said to have a dilution effect.
Management can also declare a stock-split, where all existing shares value decreases by fifty percent, but the number of shares in issue doubles. Therefore if a shareholder held 20 shares at $1/share, after the stock split he/she will hold 40 shares at $0.50/per share. There is no dilution because the shareholder’s portion of issued shares remains unchanged.
Now you know the lingo. Google your local broker and, if the price is right, Buy, Buy, Buy!
Sources: https://www.bloomberg.com/, https://afx.kwayisi.org/, https://www.investopedia.com/
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