Stock Market Notes

Stock Market

Learning Objectives

• Appreciate long-term financing through equity securities.
• Determine the proper compositions of the stockholder’s equity.
• Differentiate common stocks and preferred stocks.
• Compute how many shares are to be issued in raising capital.
• Determine the market price of the share.

Equity Securities Market

• Shareholder's Equity (Equity): Represents the difference between a company's assets and liabilities.
• Equity fundamentally represents ownership in a firm.
• Investors provide cash to purchase equity and these are traded in financial markets via equity instruments.
• Equity Instrument: A financial instrument where the issuer (company) agrees to pay an amount to the investor based on the company's future earnings (if any), after settling all required payments (e.g., interest for debt security holders).
• Shares (or stocks) represent ownership in a company.
• Shareholder/Stockholder: An individual or party who owns shares.
• Shareholders own a percentage interest in a company relative to the total outstanding shares.
• Stock Certificates: Legal documents certifying the ownership of a specific number of shares.
• In equity instruments, the company is the issuer, and shareholders are the investors.

Authorized Capital Stock and Shares

• Authorized Capital Stock: The total maximum amount stated in the Articles of Incorporation that can be subscribed to or paid by investors if the shares have a par value.
• Par Value: The nominal value of the share indicated on the stock certificate.
• A company cannot issue additional shares exceeding its authorized capital stock.
• Companies can increase their authorized capital stock by amending their Articles of Incorporation and gaining approval from regulatory agencies.
• If shares do not have a par value, the corporation has an authorized number of shares it may issue, but no authorized capital stock.
• Outstanding Shares: Total shares of stock issued under binding subscription agreements to subscribers or stockholders, whether partially or fully paid, excluding treasury shares.
• Treasury Shares: Shares repurchased by the company
• Issued Shares: All shares issued by the company, whether outstanding or treasury shares.

Business Organizations in the Philippines

• Sole Proprietorship:
  • An individual personally owns the business.
  • No distinct personality from the owner, thus the owner has unlimited liability for debts and obligations.
  • The owner has full control over decision-making.
• Partnership:
  • Formed when two or more persons contribute money, property, or industry to a common fund to divide profits and ownership.
  • The partnership is a separate legal entity from the partners, but partners are still personally obliged to pay the debts of the partnership.
  • Creditors can compel the partners to pay up to the extent of their personal assets in case of bankruptcy.
• Corporation:
  • A legal entity with a personality separate and distinct from the owners/shareholders.
  • Limited liability protects shareholders from losing more than they invested in the company.
  • Shareholders' responsibility to creditors is limited to their capital contribution.
  • Ownership is evidenced through shares, and only corporations can issue shares.
  • Investors prefer corporations due to the concept of limited liability.

Methods of Earning in Equity Securities

Compositions of Equity

1. Capital Stock: Issued by companies to raise capital, often to fund growth. It includes a combination of preferred and common stock. Investors may benefit from dividends and appreciation as the business grows. It can also be exchanged for assets to facilitate growth.
2. Authorized Capital Stock: The maximum amount of capital a company is permitted to raise via stock sales. Additional equity requires SEC approval to increase the authorized capital amount.
3. Stock Certificate: A legal document certifying ownership of shares, including:
   • Shareholder's name
   • Number of shares owned
   • Date of issuance
   • Corporation's name
   • Official corporate seal and signatures
   • Certificate number
4. Subscribed Capital Stock: The portion of authorized capital that investors have agreed to purchase and committed to contribute. It indicates the total value of shares shareholders have committed to, even if not fully paid up.
5. Additional Paid-in Capital (Share Premium): The amount investors pay above the par value of a company's stock, recorded in the equity section of the balance sheet.
6. Retained Earnings: Cumulative net income earned over the company's history, minus dividends paid to shareholders. It represents profit reinvested in the business.
7. Treasury Stock: Shares that a corporation has reacquired. These shares are held by the company and are not considered outstanding shares.

Comparison between Debt vs. Equity

Debt

• Creditors or lenders have the legal right to receive payment on the amount invested or lent out.
• Payment is required, and the issuing business is compelled to repay once the debt becomes due.

Equity

• Shareholders only have an expectation of being repaid in the future.
• There is no certainty that the money used to pay for the shares can be recovered.
• The value that shareholders may enjoy depends on the future performance of the company.
• Equity instruments are riskier compared with debt instruments.

Voice in Management

• Debt: No. Creditors do not have voting privileges on company matters and rely on the contractual obligation inherent to the debt.
• Equity: Yes. Shareholders have voting rights on certain corporate decisions such as the election of directors.

Claim on Assets and Income

• Debt: Prioritized over equity. Creditors' claims (interest on debt and principal repayment) are paid before shareholders' claims.
• Equity: Subordinate to debt. Creditors must be satisfied before dividends can be distributed to shareholders.

Type of Financing

• Debt: Temporary.
• Equity: Permanent.

Maturity

• Debt: Has a maturity date when the debt needs to be repaid.
• Equity: Has no maturity date, although shares have a secondary market with fluctuating prices.

Risk Profile

• Debt: Lower risk relative to equity. Return of invested money (and interest) is more certain due to the contractual obligation.
• Equity: Higher risk relative to debt. There is high uncertainty of returns associated with shares and fluctuating prices in the secondary market.

Return Expectations

• Debt: Lower compared to equity; return is only up to the contracted interest.
• Equity: Higher compared to debt; return (dividends and capital appreciation) may increase infinitely as long as the business grows.

Tax Implication

• Debt: Interest can be used as a tax-deductible expense by the issuing company.
• Equity: Dividend payments to shareholders cannot be used as a tax-deductible expense by the issuing company.

Types of Stocks

Common Stocks

• Typical features of common stocks:
  1. The right to receive dividends after satisfying the dividend requirements of the preferred stockholders.
  2. Preemptive Right: The right to buy new shares of stock before they are offered to the public to maintain a proportionate percentage of ownership and avoid dilution.
  3. Holders of common stock have the right to vote in matters like the election of the Board of Directors, employee stock award plans, and mergers; hence, to participate in the management.
  4. The right to share in the distribution of assets after all preferential claims have been met.
  5. The right to periodic financial reports about corporate performance.
  6. The receipt of a stock certificate is evidence of ownership of the firm, which can be sold in the secondary security market.
• Advantages of Issuing Common Stocks
  1. The credit rating of the company will improve due to increased liquidity because financing through borrowing decreases the firm's financial ratios about financial leverage.
  2. The dividend declaration is not required unless decided upon by the board of directors.
  3. There is no maturity date on the issued common stocks.
  4. Issued common stocks can be repurchased by the company in the form of treasury shares.
  5. It will give the company a higher net income because the dividends declared are not deductible.
• Disadvantages of Issuing Common Stocks
  1. It dilutes the EPS of the company. With increased common shares outstanding, the EPS will decline.
  2. With increased common shares outstanding, the current stockholders' interest will decrease if the pre-emptive right is not practiced.
  3. The dividends declared are not tax-deductible.
  4. The retained earnings declared as dividends will be distributed to a greater number of stockholders.
  5. The flotation costs associated with a common stock issue are higher than with preferred stock and debt financing.

Preferred Stocks

• Preferred stocks combine features of both equity and debt, typically issued to raise capital.
• Key Features:
  1. Priority in Dividends:
     • Preferred shareholders receive dividends before common shareholders.
     • Dividends are usually fixed and specified at the time of issuance.
     • If dividends are not paid in a given year, they may accumulate (cumulative preferred stock).
  2. Preference in Assets During Liquidation:
     • In case of company liquidation, preferred shareholders have a higher claim on assets than common shareholders but are subordinate to creditors.
  3. Fixed Dividends:
     • Preferred stocks often pay a fixed dividend rate, making them similar to fixed-income securities.
  4. Limited Voting Rights:
     • Preferred shareholders generally do not have voting rights in the company's decisions, unlike common shareholders.
  5. Convertible Options:
     • Some preferred stocks are convertible into a specified number of common shares, providing potential for capital appreciation.
  6. Callable Feature:
     • Companies may have the right to redeem (call) preferred shares after a certain date at a predetermined price.
  7. Cumulative Feature:
     • If dividends are omitted, they accumulate and must be paid out before dividends can be paid to common shareholders.
  8. Non-participating or Participating:
     • Non-participating preferred stocks receive only fixed dividends.
     • Participating preferred stocks may receive additional dividends if the company's profits exceed certain levels.

Categories of Stocks

1. Blue Chip Stocks:
   • Shares of the most established, financially stable, and reputable companies.
   • Known for consistent performance, large market capitalization, and leadership in their respective industries.
   • Features of Philippine Blue-Chip Stocks:
     1. Leadership and Market DominanceMajor players and often industry leaders.
     2. Stable PerformanceConsistent earnings and dividend payments.
     3. High LiquidityFrequently traded, making it easier for investors to buy and sell shares without significantly affecting prices.
     4. Reputation and Credibility Known for strong corporate governance and reliability.
     5. Representative of the Philippine EconomyOften included in major indices like the PSE Index (PSEi), which comprises the top 30 companies.
   • Examples: Ayala Corporation (AC), SM Investments Corporation (SM), Banco de Oro Unibank (BDO), Jollibee Foods Corporation (JFC), Philippine Long Distance Telephone Company (PLDT), Universal Robina Corporation (URC), San Miguel Corporation (SMC).
2. Penny Stocks:
   • Publicly listed companies with very low share prices, typically below PHP 1.00 or PHP 5.00 per share.
   • Often from small-cap companies and can be highly volatile and speculative.
   • Examples: Premiere Horizon Alliance Corporation, Manila Mining Corporation, Manila Bulletin, Fruitas Holdings Inc.
3. Income Stocks:
   • Shares of companies that regularly pay out dividends, providing a steady stream of income.
   • Typically issued by well-established companies with stable earnings.
   • Characteristics of Income Stocks in the Philippines:
     1. Regular Dividends: Consistent or predictable dividend payments, often quarterly or annual.
     2. Stable and Mature Companies: Usually large, established companies with steady cash flows.
     3. Lower Growth Potential: While they provide reliable income, their capital appreciation might be slower compared to growth stocks.
     4. Less Volatility: Tend to be less volatile, making them suitable for conservative investors.
     5. Dividend Yield: The dividend yield (dividend relative to stock price) is an important metric; higher yields are often preferred by income investors.
   • Examples: San Miguel Corporation (SMC), Philippine Long Distance Telephone Company (PLDT), Bank of the Philippine Islands (BPI), Metro Pacific Investments Corporation (MPI), Ayala Land (ALI).
4. Value Stocks:
   • Shares of companies considered undervalued relative to their intrinsic worth.
   • Often measured using financial ratios like P/E (Price-to-Earnings), P/B (Price-to-Book), and dividend yield.
   • Stable earnings, strong fundamentals, and trade below historical averages or peer valuations.
5. Growth Stocks:
   • Shares of companies expected to grow faster than the overall market or their industry.
   • Reinvest earnings into expanding operations rather than paying high dividends, aiming for capital appreciation.
6. Defensive Stocks:
   • Shares of companies that tend to remain stable and generate consistent earnings regardless of economic climate.
   • Less sensitive to economic cycles and are often considered safer investments during economic downturns.
   • e.g., Food and utilities companies.
7. Cyclical Stocks:
   • Shares of companies whose performance and stock prices are closely tied to the economic cycle.
   • Perform well during economic growth but may decline during downturns.
   • Characteristics of Cyclical Stocks in the Philippines:
     1. Sensitivity to Economic Conditions: Revenues and profits fluctuate with the economic cycle.
     2. Industries Involved: Sectors like manufacturing, construction, automotive, tourism, and commodities.
     3. Performance Pattern: Tend to outperform during periods of economic boom; may suffer losses during slowdowns.
     4. Potential for High Returns: Can generate significant gains when the economy is expanding.
     5. Higher Risk and Volatility: More susceptible to economic shocks and market sentiment.
8. Treasury Stock:
   • Shares that a company has issued and subsequently repurchased from the marketplace.
   • Held in the company's treasury and are not considered outstanding shares available to the public or for dividends.

Initial Public Offering (IPO)

• The process by which a private company offers its shares to the public for the first time to raise capital, becoming publicly listed on the stock exchange.
• IPO Process in the Philippines:
  1. Preparation Stage:
     • Company conducts due diligence.
     • Prepares documents, including the prospectus.
     • Engages underwriters (usually investment banks) to assist.
  2. Filing with Regulatory Authorities:
     • Submits registration statements and other required documents to the Securities and Exchange Commission (SEC).
     • SEC reviews disclosures for transparency and compliance.
  3. Pricing and Marketing:
     • Determine the offer price per share.
     • Conduct a roadshow to promote the offering.
     • Book-building process to gauge demand.
  4. Offer Period:
     • Shares are offered to the public for subscription.
     • Investors submit their bids or purchase orders.
  5. Settlement and Listing:
     • Shares are allocated after the offering period.
     • The company’s shares are listed on the PSE (Philippine Stock Exchange).
     • Trading begins publicly.
• General Criteria for Listing:
  • Operating History Requirement: Three (3) years of engaging in materially the same business.
  • Board of Directors Requirement: Minimum of seven (7) directors, two (2) of which or 20% of the board have to be independent, and each director should have at least one (1) share in his name.
  • Profit Test:
    • A.) Cumulative net income, excluding non –recurring items, of at least Php75 million for three (3) full fiscal years immediately preceding the application for listing; AND
    • B.) Minimum net income of Php50 million for the most recent fiscal year
    • Audited consolidated financial statements for the last three (3) full fiscal years preceding the filing of the application are required.
    • Financial statements must be accompanied by an unqualified external auditor’s opinion.
  • Stockholders’ Equity Requirement: Stockholders’ equity must be at least Php500 million for the most recent fiscal year.
  • Minimum Number of Stockholders upon Listing: At least 1000 stockholders, each owning stocks equivalent to at least one (1) board lot.
  • Minimum Public Offering: 20% upon and after listing
• Advantages to Going Public with an IPO:
  1. Access to Capital: Raises significant funds for business expansion, research, debt repayment, or other corporate needs.
  2. Enhanced Credibility and Visibility: Enhances the company's reputation, credibility, and brand recognition.
  3. Liquidity for Shareholders: Provides an exit strategy for early investors, founders, and employees holding stock options.
  4. Attraction of Talent: Public companies can use stock options as part of compensation packages to attract skilled employees.
  5. Facilitates Future Fundraising: A listed company can issue additional shares more easily in the future through secondary offerings.
  6. Valuation Benchmark: The IPO process establishes a market-driven valuation of the company.
• Disadvantages of IPO:
  1. High Costs: Significant expenses related to underwriting, legal, accounting, regulatory fees, and marketing (roadshows).
  2. Regulatory Burden: Increased regulatory compliance, reporting requirements, and disclosure obligations under SEC and PSE rules.
  3. Loss of Control: Original owners may experience dilution of ownership and voting power.
  4. Market Pressure: Public companies face pressure to meet quarterly earnings expectations.
  5. Vulnerability to Market Fluctuations: Share price can be volatile, influenced by market sentiment, economic conditions, or company performance.
  6. Potential for Takeovers: Increased liquidity might make the company vulnerable to hostile takeovers if ownership becomes dispersed.
  7. Management Distraction: Preparing for IPO and managing the ongoing demands of being a public company can divert management focus from core business activities.

Investing Procedure

• Step 1: Choose a Broker

  • All stock market transactions are done through stockbrokerage firms or trading participants (TPs) accredited by the PSE.
  • There are two types of TPs in the PSE – traditional and online.
  • The former will assign a trader or agent to execute your transactions while the latter allows you to trade on your own through their online facility.
  • Decide whether you want to go with a traditional or online TP.
  • Here are the things that may help you shortlist potential TPs: minimum investment requirement, types of services they offer, commissions and fees, client feedback, and for online TPs, the features and user- friendliness of their trading platform.

• Step 2: Open an account

  • Contact your chosen TP and find out their account opening requirements
  • Submit the required documents and identification cards and proceed with the account opening process.
  • The TP will do its Know Your Customer procedure.

• Step 3: Give your Order

  • Take the first step to becoming a shareholder by giving your buy order to your assigned trader or by posting a buy order through your online trading account.
  • Please note that online accounts are required to be pre-funded before entering buying orders.
  • The buying order is reflected on the trading terminal and is matched with a sell order with the same or better price.
  • Your TP should immediately confirm your done trades and subsequently, an official confirmation or invoice should be delivered to you.
  • For investors using an online platform, the confirmation is reflected real-time in the trading platform of the online TP.
  • Inform your TP if you would like to have a stock certificate for the shares you bought so they can inform you of the process and fee for this procedure.

• Step 4: Pay before your settlement date

  • Payment for shares bought and delivery of shares sold should be made before the settlement deadline on settlement date which is two (2) clearing days from the transaction date (T+2).
  • To illustrate, for a transaction done on Monday, payment and delivery by the buyer and seller, respectively, should be done before the settlement deadline on Wednesday.
  • For investors dealing with online TPs, payment for shares bought and delivery of shares sold happens on the transaction date.

• Step 5: Receive Your Proceeds/Shares

  • You will receive from your TP either the proceeds of the sale of your stocks or proofs of ownership of stocks you bought (confirmation receipt and invoice) after the settlement processing on T+2.
  • Make sure that the corresponding confirmation receipt and invoice are provided by your TP.

  *Note however, that while the clearing and settlement cycle is completed within 2 clearing days after the transaction date, purchased shares are immediately reflected in the portfolio of the buying investor and the same investor has the option to sell the shares before T+2 of the initial transaction.

Equity Transactions and Settlement

• All equity transactions have a settlement period of T+2 (trading day + 2 clearing days).
• Sellers must deliver shares to their TP, and buyers must pay the transaction cost within 2 clearing days after the trade.
• Settlement is done via the book-entry system (through the Philippine Depository & Trust Corp. or PDTC).
• Investors can hold their certificates (uplift) or deposit (lodge) them in PDTC through their TP-participant account.

Board Lot System

• Equity trading is done by the board lot or round lot system.
• The Board Lot Table determines the minimum number of shares to buy or sell at a specific price range.
• The minimum investment varies and depends on the market price and the corresponding board lot.
• Prices move through a scale of minimum price fluctuations.

Buying Transaction Example

• Mr. X wants to buy a stock at ₱10.00.
• Based on the Board Lot Table, he can buy in multiples of 100 shares.
• If Mr. X wants to buy 1,000 shares, his cash outflow is calculated as follows:

Selling Transaction Example

• Ms. Y wants to sell a stock trading at ₱10.00.
• Based on the Board Lot Table, she can sell in multiples of 100 shares.
• If Ms. Y wants to sell 1,000 shares, her cash inflow is calculated as follows:

*Note: (If a selling client has certificates, he/she needs to have this converted into book-entry form in the PCD system. A cancellation fee of ₱20.00 + 12% VAT and transfer fee of ₱100.00 + 12% VAT will be charged. In the illustration above, the combined cancellation fee and transfer fee to be paid by the selling client will amount to P134.40 (P22.40 + P112.00)

Transaction Fees & Taxes

• Transaction Fee:
  • The Exchange collects $1/200$ of 1% (0.5 basis points) on gross value for every buy and sell transaction executed.
  • Exclusive of 12% value-added tax (VAT).
• Clearing & Settlement Fee:
  • The Securities Clearing Corporation of the Philippines collects 1 basis point on gross value for every buy and sell transaction executed.
  • Inclusive of 12% VAT.
• Brokerage Commission
  • Trade transactions covering equity and equity-related products has a maximum commission rate of 1.5% of the total transaction cost plus 12% VAT.
  • There is no prescribed minimum commission*.
  • A stock brokerage firm may set its own commission schedule.
• Upliftment/Withdrawal Fee
  • If a buying client opts for a stock certificate to be issued in his name, he must make the request through his broker who will then issue the upliftment request through the PDTC system.
  • Upon receipt, PDTC will then submit the request to the transfer agent for the issuance of the certificate.
  • PDTC will charge the broker an upliftment/withdrawal fee of Php50 per certificate issuance request.
  • The transfer agent will charge their usual issuance fee per certificate on top of PDTC’s upliftment/withdrawal fee.
• Cancellation Fee
  • If a selling client has physical certificates, he must have the certificates converted into book-entry form in the PDTC system by requesting, through his broker, for a direct transfer (DT) with the transfer agent, which costs Php100 (plus 12% VAT) per certificate for the transfer of ownership of shares to PDTC Nominee Corporation (PCNC).
  • In addition to the DT fee, a client must pay cancellation fee of Php20 (plus 12% VAT) to the transfer agent for cancellation of the certificates to be lodged in PDTC (for lodgment of shares). This is applicable only to listed equities.
• Stock Transaction Tax
  • Sales of equities listed and traded on the Exchange are subject to a stock transaction tax of $3/5$ of 1% (60 basis points) of the value of transaction charged to the seller, in lieu of the capital gains tax.
  • The sale, barter, or exchange of shares of stock listed and traded at the PSE are exempt from documentary stamp tax.
• Withholding Tax
  • Under the National Internal Revenue Code of 1997, and except in cases where tax treaties are in force, dividends received from domestic corporations are subject to a withholding tax of 10% if the recipient is a citizen or resident alien, 20% if the recipient is a non-resident individual engaged in trade or business in the Philippines, 25% if the recipient is a non-resident individual not engaged in trade or business in the Philippines, and 30% if the recipient is a non-resident foreign corporation.
  • Dividends received by domestic and resident foreign corporations are not subject to tax.
  • The rate of income tax withheld on dividends paid to a non-resident foreign corporation may be reduced to 15% if the country in which the non-resident foreign corporation is domiciled (a) imposes no taxes on foreign-source dividends or (b) allows a credit against the tax due from the foreign non-resident corporation for taxes deemed to have been paid in the Philippines equivalent to 15% of such dividends.

Schedule of Transaction Fees and Taxes Levied on Investors

Types of Orders

• All stock trades consist of at least two orders - one buy and one sell order - usually with one order to enter the trade, and one or more orders to exit the trade.
• A single order is either a buy order or a sell order.
• An order can be used either to enter a trade or to exit a trade.
• If a trade is entered with a buy order, then it will be exited with a sell order, and vice versa.
• For example, if a trader expected the market's price to go up, the simplest trade would consist of one buy order to enter the trade, and one sell order to exit the trade.
• Conversely, if a trader expected the market's price to go down, the simplest trade would consist of one sell order to enter the trade, and one buy order to exit the trade.
• Traders have access to many different types of orders according to price and validity, which they can use in various combinations to execute their clients' trades.
• With this, a stockbroker's commission may depend on which type of order an investor prefers to take.

A. Market Order

• The buying or selling of stocks without a specified price, or immediately at the prevailing market price when the order is executed, whatever the price may be.
• Market order is the simplest and quickest way to get your order completed.
• It is often subject to the lowest commission since this is the easiest to execute.
• Although being practiced in some other markets, this type of order is rarely used in the local equities market.

B. Limit Order

• Entered with a specified price known as the limit price.
• This allows investors to buy or sell at their desired buying or selling price levels.
• The primary difference between a market order and a limit order is that the stockbroker cannot guarantee that the former will be executed at a specific price.

C. Market on Opening/Closing Order

• Accepted only during pre-open and pre-close periods and executed at the opening/closing price of the instrument.

D. Market-to-Limit Order

• An order entered for immediate execution at the best price with whatever volume available and remaining quantity will be queued as a limit order.

E. Stop Order (Stop Loss/Stop Limit)

• Stop Orders are triggered when a specified price limit is reached.
• It becomes a market order as soon as its trigger price limit is reached.
• There are two (2) kinds of stop orders:
  • a) Stop Loss Order stays inactive and is not displayed in the market until a trade occurs at the order's trigger price. It is immediately treated as a Market Order when the order is triggered. It specifies only the trigger price.
  • b) Stop Limit Order is the same as the stop loss order wherein it also stays inactive and is not displayed to the market until a trade occurs at the order's trigger price. Instead of specifying only one price, a stop limit order specifies two prices: the trigger price and the limit price, which must exceed the limit price.

Market Capitalization (Market Cap)

• Definition: Market capitalization is the total market value of a company's outstanding shares of stock.
• It is calculated by multiplying the current share price by the total number of outstanding shares.
• Formula: $Market Capitalization = Share Price \times Total Number of Outstanding Shares$
• Market Capitalization Categories:
  • Large Cap: Companies with a market cap above $10 billion.
  • Mid Cap: Companies with market cap ranging from $1 billion to $10 billion.
  • Small Cap: Companies with a market capitalization between $250 million to $1 billion.
  • Micro Cap: Relatively young penny stocks. Not considered safest investment.

Market Price per Share

• Definition: The current trading price of a single share of a company's stock in the stock market.
• Key Points:
  • Dynamic: Fluctuates throughout the trading day based on supply and demand.
  • Determined by: Market forces, investor sentiment, company performance, economic factors, and market news.