What are holding companies? Understanding Parent and Subsidiary corporate relationship

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 source: http://philippines.starbucks.com

Have you ever thought who owns the Starbucks franchise in the Philippines?

Rustan Coffee which is a subsidiary of Rustan Group owns Starbucks Philippines(need clarification here) which  is the franchisee of Starbucks in the Philippines.

If you look at the relationship between these companies one can clearly see which stands as the parent and which stands as the subsidiary. By definition a subsidiary is a corporation which is controlled by another company while a parent company is a corporation who has control over another company. 

The important term to remember is "control". What is control then?

Basically control is defined as having an influence over another. So in a corporate setting control is achieved if one company owns a majority share in a company thus giving such company the power to make decisions due to the majority voting rights.

The Philippine Stock Exchange have an index named Holding Firms. This index primarily have all the conglomerate that has shareholdings in businesses of various industry. 

To name a few the likes of JGS(JG Summit) of the Gokingwei's, AC(Ayala Corp.) of the Ayala's, SM(SM Investments) of the Sy's, LPZ(Lopez Group) of the Lopez's, and MPI(Metro Pacific Investments) of Manny V. Pangilinan of First Pacific are the known holding firms in the Philippines.

It is possible that a Parent/Holding Company is also a subsidiary of another company. In this case such company will be called the ultimate  parent company.  An ultimate parent company may be a domestic corporation or a foreign corporation. 

In that case the Parent corporation prepares its Financial report with two presentation that is as the corporation by itself and as consolidated report.(This topic will be discuss in another post).

Now why does one need to know such?

This is important because it gives an idea how a stock will be performing. So basically since the earnings of a parent company comes from its subsidiary one can gauge the value of a holding company through its subsidiary. 

An example is AC(Ayala Corp) with the good performance of BPI(Bank of the Philippine  Island) one might think that it is good to buy AC(which is good because AC is considered as a fundamentally sound corporation) but looking at its telecom business GLO(Globe Inc.) which has suffered set back in its operations due to the sluggish telecom industry one might concentrate more on BPI rather than investing its bulk of funds in AC.

At the same time it is also noteworthy to know that though such is interconnected it seems that the subsidiary and the parent are independent from one another.

So one still has to understand the nature of the company and the industry they are in. And it would be of great help knowing the diversified business a company ventures into.

 

Investing word of the day: Dividend

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source: http://shareinvestornz.blogspot.com 

A friend in an online forum posted a question regarding dividend and I would like to explain it further.

This is from the Philippines's Corporation Code under Batas Pambansa Bilang 68(Source: www.chanrobles.com)

Title IV: Powers of Corporations

Sec. 43. Power to declare dividends. - The board of directors of a stock corporation may declare dividends out of the unrestricted retained earnings which shall be payable in cash, in property, or in stock to all stockholders on the basis of outstanding stock held by them: Provided, That any cash dividends due on delinquent stock shall first be applied to the unpaid balance on the subscription plus costs and expenses, while stock dividends shall be withheld from the delinquent stockholder until his unpaid subscription is fully paid: Provided, further, That no stock dividend shall be issued without the approval of stockholders representing not less than two-thirds (2/3) of the outstanding capital stock at a regular or special meeting duly called for the purpose. (16a)

Stock corporations are prohibited from retaining surplus profits in excess of one hundred (100%) percent of their paid-in capital stock, except: (1) when justified by definite corporate expansion projects or programs approved by the board of directors; or (2) when the corporation is prohibited under any loan agreement with any financial institution or creditor, whether local or foreign, from declaring dividends without its/his consent, and such consent has not yet been secured; or (3) when it can be clearly shown that such retention is necessary under special circumstances obtaining in the corporation, such as when there is need for special reserve for probable contingencies. (n) 

In stock investing once a stock is traded in the stock market the company itself does have any power to control such that is why any stock has a market value. A stock's market value is dictated by how any sane investor values a company's stock and how willing one is to buy at such price. 

One might notice the likes of TEL(Philippine Long Distance Telecommunications) which has a par value of Php 5.00 but a market price of Php 2,736.00.

Source: http://technogra.ph
  

Now what is a dividend then?

source: http://www.etftrends.com

Though the company has no control on the price of issued stocks, one of the reasons why me and you buy stocks of such company is that we will profit from it. A company as stated in the Corporate law above has the power to declare dividends out of its unrestricted retained earnings. As an investor we look forward on returns from the company which we received in the form of dividends. 

So besides from the possible gain from price appreciation of a stock, me and you can hold onto the stock and wait for the company's dividends. 

The question now are the following:

1. How much is the dividend an in what form?

2. Who approves a company's dividend?

3. How often is the dividend?

4. How come some companies don't declare dividends?

Question number one:How much is the dividend an in what form?

As stated in the Corporate Law  a company can declare dividends up to its unrestricted retained earnings. What is "unrestricted retained earnings" you ask? If you have been browsing the PSE website and have downloaded any company's 17Q report you can check in the Equity section a caption entitled Retained Earnings. In simple terms it is the net income of the company accumulated over the years of its operations. The company can declare a cash dividend, a property dividend, or a stock dividend.

Question number two: Who approves a company's dividend?

The board of directors of the company approves the dividend declaration. In the case of a stock dividend a vote not less than 2/3 of outstanding capital stock is required to ratify such decision. The effect of stock dividend is only to increase the number of shares held by the shareholder but in the company's books only a transfer from Retained Earnings to the Capital stock occurred thus the market capitalization of the company remains the same. What one can gain from stocks arising from stock dividend is when such is sold in the new market price because it is as if you profited 100% from it.

Question number three:How often is the dividend?

Dividends are base on company's performance. If the company has performed well they can declare dividends and when not well there is a likelihood  that there will be no dividend. But remember what the Corporation law mentioned that is a company can declare dividends out of unrestricted Retained earnings. A company might suffered a loss in its operation  this year but if such has a positive retained earnings then the company can still declare dividends. Most companies declare once a year and some generous ones give 2 to 4 times a year

Question number four: How come some companies don't declare dividends?

Some companies don't declare dividends for the following reasons as stated in the corporate law:

1. When justified by definite corporate expansion projects or 

    programs approved by the board of directors

2.When the corporation is prohibited under any loan 

   agreement with any financial institution or creditor, 

  whether local or foreign, from declaring dividends without 

  its/his consent, and such consent has not yet been secured

3. When it can be clearly shown that such retention is 

   necessary under special circumstances obtaining in the 

  corporation, such as when there is need for special reserve 

  for probable contingencies.

What are stocks anyways?

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source: http://www.zdiaz.com/

Hey wait a minute what are stocks anyways?

I know I have been babbling things about investing in stocks and yet I haven't explained yet what are stocks. So I am writing these to share you something about stocks..... I'll make the story as short as possible :)

There are 3 basic forms of business organization. These business models or layout are primarily based on the ownership of a person or persons involved has on the business. These are Sole Proprietorship, Partnership, and Corporation.

Since our area of concern is about stocks I will just make a short explanation about Sole Proprietorship and Partnership for comparison purposes.

Sole proprietorship, the name says it all. It is a business owned or under the name of one person. It is like a "tindahan" with the name "Tindahan ni ALlng Nena". The business may be owned or maybe run by the family of Aling Nena but as regards to recognition the business is under Aling Nena's name thus she is the Sole owner.

source: http://video.tellytube.in/tindahan/

Partnership in Philippine law is formed when 2 or more persons enter into an agreement to join and form a business and share earnings and losses.Also under Philippine law when partners agree to join and form such to operate a business a juridical person is created thus the partnership stands as one juridical person in the eyes of the law under the Partnership Code of the Philippines and the partners represent the partnership.When one or some of the partners die, withdraw, or sell his interest in the partnership, the partnership is dissolve and the remaining partners has the option to continue the partnership by agreeing to new agreement or to totally dissolve the partnership.(If this one seems nosebleed to you better ask your lawyer or CPA friend to further expound about this topic I hope they don't charge you consultation fee).

And now about the topic I should have discuss in the beginning.

Here is the definition of a corporation from the Philippines Corporation Code or Batas Pambansa Blg. 68:

Sec. 2. Corporation defined. - A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence.(taken from http://www.chanrobles.com/legal5title1.htm#TITLE%20I)

Corporation is business model where at least 5 but not more than 14 incorporators, which must be natural persons, form the corporation requiring at least that 25% of the authorized shares is subscribed and that 25% of the subscribed shares are paid. From there on ownership of the company can be transferred from one person to another through sale, inheritance, or donation and the remaining unsubscribed shares can be issued to interested investors or through a stock market by way of an Initial Pubic Offering(IPO).

Stocks or Shares of stocks represent one's ownership in the stock-corporation in particular because there are corporations which are non-stock corporation(again ask your lawyer or CPA friend to explain these further). As stated in the definition corporations has the "right of succession" meaning stock ownership can be transferred from one person to another. In law person can be natural person or juridical person(again ask your lawyer or CPA friend about this).

A corporation's stock could either be a common stock(share capital) or a preferred stock(preference share). To defined common stock let us first define preferred stock which is defined as stocks that carry no voting rights(with some special cases where such stocks can vote), but may carry priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend  that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock.  

Common stock is the opposite of Preferred stock. Preferred stock may have a stated rate of dividend that must be paid out first before paying out Common stock holders and will be given priority on the return of capital in case of liquidation. In a way it has the qualities of a loan or bond because of the attached rate that the company must pay out first to each Preferred stock holder before paying some to common stock holders.

The good thing with this is that a Preferred stock share in the company's earnings is limited to the rate stated, so when the company has performed well the remaining distributable earnings all goes to the common stock holders after satisfying the amount due to preferred shares holder.

The proceeds of the initial sale of the stock from the company goes to the equity section of the company where we based the Book value per share. A stock may have a par value but could be bought at above par thus when you read a company's Balance sheet a portion of the Stockholder's Equity has the section Paid in Capital. This represent the amount paid by the investor on top of the par value. In the company's book it is not recorded as income because such transaction is related to financing activity rather than its operating activity.

When the initial investor sales his or her stocks to another person the proceeds now goes to the investor since it is mere sale of his or her property to another which may be at a profit or at a loss. Thus stock market are there for such transactions. Stock markets has rules to follow to make sure the transfer of stocks from one person to another is properly recorded and that the investing public interest's is safeguarded against fraud. 

Since the stocks that are traded are now properties of their respective owners, the price of each stock now is dictated by market forces just like in any ordinary market place.We sell our property to gain and not to lose thus prices change and the price now is called market price.

Though the stock's market price is not dictated by the company that issued it, investors still look into the operation of the company to gauge its value and demand a higher price in times that the company performs well. Thus a company that reported a good performance will have its traded shares having a higher market price because investors sees that as a value added to the stock which one can get when such is a holder of it. These is what we call dividend. But since such could still be sold in a stock market one would normally sell to gain profit from there investment.