Marketed as simple and easy to own, stocks are actually the most complex and emotionally challenging of all asset classes. Powerlessness,
unmanageability, regrets, fears, social pressures, herd behavior, and complexities galore are the norm. Stock investors are primarily an optimistic group. They believe that stocks they purchase will increase in value. They all know stories of stocks that increased in value by 100 times or more. The potential rewards appear unlimited. Of course, most stock investors are aware of the risk of loss, so they diversify and employ other cautions. Still, every stock investor believes that one or more of his stocks or mutual funds will have fantastic returns.
Businesses issuing stock encourage this belief and are all too happy to accept the investor’s cash.
An equity investment has none of the contractual certainty or specificity of a debt investment such as a bond (Appraisal Institute, 2001). Ordinary shares in companies can be purchased through a stock market or via a broker. Investors effectively own a share of the company’s assets, that is, its equity, subject to prior claims of operating expenses and debt service, and will receive a regular income or dividend (based on company profits), usually twice a year. The ‘dividend yield’ is similar to the income or running yield on a bond and is calculated by dividing the dividend per share by the market price of the share.
Unlike bonds income from equities is not known in advance as dividends are linked to profits which, in turn, are linked to company performance and economic activity. Also, there is no redemption date so shares must be sold on a secondary market to realise capital. Prices on the secondary market are determined by supply and demand and vary according to future cash-flow expectations and perception of risk (Ball et al., 1998). Equity investments can yield a high rate of return but are more volatile and risky than debt investments such as bonds. Consequently market knowledge is needed if informed decisions are to be made and this incurs fees. Nevertheless, millions of pounds are traded in debt and equity markets daily, traders are sophisticated and well informed, investments are often professionally rated for risk and transaction prices are reported daily. Changes in yields of equities respond quickly to changes in supply and demand due to the efficiency of the equities market. Consequently data from these markets provide an objective basis for property market assumptions, particularly regarding expectations of debt capital performance (Appraisal Institute, 2001).