How to de­ter­mine share prices

Mar­ket per­cep­tion in­flu­ences the price of pref­er­ence shares

Finweek English Edition - - Creating wealth - BY VIC DE KLERK vicd@fin­week.co.za

I AGREE with most of the state­ments in the let­ter be­low but al­low me to again dwell on the cap­i­tal value or prices of per­pet­ual pref­er­ence shares. This will also ad­dress the sud­den de­cline in the value of th­ese shares in May last year.

The value of per­pet­ual shares should al­ways be about 100c or R100 or even R1 000, or more or less the price at which they were is­sued, pro­vided they were orig­i­nally cor­rectly priced. Absa was not. A typ­i­cal bench­mark pref­er­ence share should be one that pays a div­i­dend equal to 70% of prime and that should be trad­ing at 100% of the is­sue price. At the cur­rent prime of 12,5% the div­i­dend yield on the pref­er­ence share will be 8,75%. Div­i­dends are paid twice a year and the share price should there­fore slowly re­flect the amount of div­i­dend ac­cu­mu­lated on the share. Five months af­ter the pre­vi­ous div­i­dend, the share price of R100 nom­i­nal value should rise to about R103,50.

In a per­fect mar­ket, the prices will be R104,40 on the last day of cum div­i­dend trad­ing. On the first ex div­i­dend date, the share price should read­just to R100.

In this per­fect mar­ket the price of a pref­er­ence share should there­fore rise from R100 to R104 af­ter six months, back to R100 on the ex div­i­dend date and then up to R104 again.

The ac­tual level of the prime rate should have no ef­fect on the price of the pref­er­ence share. With the prime rate at 10,5% the yield on the typ­i­cal 70% pref­er­ence share was 7,35% and that has now im­proved to 8,75%. If the prime rate, for some rea­son, should again rise to 17%, the yield on th­ese shares will rise to a mar­ket-re­lated 12% and it should not af­fect the price of the pref­er­ence share.

The only event that does af­fect the price of pref­er­ence shares is the mar­ket per­cep­tion at a cer­tain point on what per­cent­age of prime is a fair value. That’s what caused the dra­matic change in prices be­tween May last year and cur­rent val­ues.

For some rea­son, in­vestors were happy with a re­turn of only 63% of prime last year. The mar­ket price of our typ­i­cal pref­er­ence share in May last year was there­fore R100 x 70% / 63% or R111. Late last year the mar­ket re­verted to the pre­vi­ous level of 70% of prime and all of a sud­den th­ese so-called safe in­vest­ments en­joyed a 10%-plus drop in cap­i­tal val­ues. This com­pletely de­stroyed the re­turn on th­ese in­vest­ments for the past year.

Why did the mar­ket per­cep­tions change from 63% of prime back to 70%? We sim­ply don’t know and no­body has come up with a sat­is­fac­tory ex­pla­na­tion.

Per­haps the mar­ket was just a bit silly last year. It’s per­haps a good idea to place a value of no more than 70% of prime plus the ac­crued div­i­dend on th­ese shares. The max­i­mum price should there­fore be R104 per R100 of nom­i­nal value if the is­sue price is 70% of prime.

Se­condly, re­mem­ber that the 70% of prime ap­plies only to the five ma­jor lo­cal banks, the so-called AAA com­pa­nies. Ad­just the re­quired yield to 75% for the medium cat­e­gory like PSG and 80% for the likes of As­tra­pak and Capitec. Never ever get sucked into a mar­ket when th­ese shares are trad­ing at, say, 65% or less of the prime rate.

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