Introduction to Equity Instrument Analysis

Abstract

Equity instruments call for a different approach in their analysis compared with debt securities. Compared with conventional bonds, shares do not pay a fixed cash flow during their life and do not have a fixed maturity date. Instead, the future cash flows of shares cannot be determined with certainty and must be assumed, and as they are in effect perpetual securities they have no redemption value. In addition they represent a higher form of risk for their holders. The analysis and valuation of shares therefore call for different techniques from that of bonds. In addition the interests of shareholders and bondholders sometimes often sit on opposite ends of the risk spectrum. While a firm’s bondholders are to some extent primarily concerned with financial probity and the maintenance (or upgrade) of its credit rating, shareholders gain, at least in the short term, from high-risk and high-return strategies where favourable perceptions lead to a short-term rise in the share price.