1.2.1 Public Equities

Welcome to On Judgement. Two fictional companies earn the same profit. One trades at twice the price-to-earnings multiple of the other. Is the cheaper multiple automatically the better investment? Write two possible explanations before reading on. Take a first view. You can change it when you have considered the evidence.

An ordinary share is a residual ownership claim. Shareholders may receive dividends when declared and can gain or lose as the share price changes. Owning shares does not give a right to withdraw a matching percentage of company revenue. In insolvency, creditors generally rank ahead of ordinary shareholders; exact ranking depends on the claims and legal arrangements. Market capitalisation is share price multiplied by shares outstanding. It measures the market value of equity, not the value of all claims on a business. Enterprise value also considers financing claims such as debt and cash adjustments. A large market capitalisation does not by itself establish profitability, good governance or an attractive price.

An exchange brings together orders at different prices. A completed trade has both a buyer and seller. A price can change when investors revise the prices at which they are willing to transact, including after news about profits, interest rates or risk. The number of executed buyers is not a useful explanation for every price move. The bid is a price available to a seller and the offer or ask is a price available to a buyer for the quoted size. A buyer who immediately resells crosses the spread. Quotes can change, and larger trades can move prices. A familiar ticker identifies a security but says nothing about its estimated value.

An active manager makes choices under a mandate; an index-tracking strategy aims to follow a specified index, possibly using a sample of holdings. Neither description tells you all the underlying exposures. A narrow sector index can be concentrated. An active portfolio can be highly diversified or hold relatively few companies. Growth investors emphasise future business expansion; value approaches emphasise price relative to estimated worth; income approaches focus on distributions; momentum approaches use price trends. These styles can overlap. A high dividend yield can reflect a falling share price and an uncertain dividend. A fast-growing company can still be overpriced. Style labels are starting points for analysis.

Research connects customers, competitive position, finances, management incentives and valuation assumptions. Start with lawful public sources and record their dates. An information advantage must never be treated as permission to use prohibited inside information. A strong research process also seeks evidence that could overturn the initial view. Concentration increases dependence on fewer outcomes. A manager may know a company well and still be wrong about demand, competition or the price paid. Compare returns with a relevant benchmark on a consistent cost and currency basis. A simple excess return is not automatically risk-adjusted alpha. Keep conviction conditional: state what would change your mind.

Let's work through A share return, a company value and a trading cost. Fictional Alder has 20 million ordinary shares at £8. A student portfolio buys one share for £8, receives 30p and sells it for £8.50. Separately, a security is quoted bid £98, ask £102. Calculate three different measures. Pause here and try the calculation or reasoning before continuing.

Alder market capitalisation: 20 million × £8 = £160 million. Holding-period total return: (£8.50 − £8 + £0.30) ÷ £8 = 10%, before tax and costs. Immediate purchase at £102 and sale at £98 loses £4 ÷ £102 = 3.92%. The full quoted spread is £4; it is 4% of the £100 midpoint. These denominators answer different questions.

Equity value, investment return and execution cost are different measures. Market capitalisation is not enterprise value. The spread example assumes unchanged quotes and executable size.

Now try the choices in this lesson. If your answer changes, identify the reason. Assess a public-equity idea using business evidence, price and portfolio risk. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.