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Book title: Understanding Financial Markets & Instruments
Author: Braam van den Berg

Chapter 2: The Equity Market

2.1    Introduction to equity and the JSE 
2.2    The structure and role of the JSE 
2.3    Trading of listed equity 
2.3.1 The JET system 

2.3.2 Single and dual trading capacity  
2.3.3 Purchasing and selling shares  
2.4    The listing of a company's shares on the JSE 
2.4.1 The Main Board Financial redevelopment sector Industrial development sector 
2.4.2 Development capital market (DCM) 
2.4.3 The venture capital market (VCM) 
2.4.4 Warrants 
2.5    Investment and share prices

2.1 Introduction to equity and the JSE

In the definition of the equity of a company, equity is often referred to as being the shares of a company. It is, however, much broader than just the shares of a company, since equity includes all the risk capital of a company. The risk capital includes the reserves, irredeemable preference capital in issue, minority interests less goodwill and, in some cases, debentures. This chapter concerns shares as a part of equity.

A share in a company is defined as being a right in the assets, profits and management of the company, equal to the rights of any other similar share, and this right is indivisible. A share is represented by a share certificate (see appendix 2 for an example), and gives the owner of the certificate, among others, the above rights and a vote at the annual general meeting of the company in matters concerning the company. The owner of the certificate may share in the financial benefits of the company (e.g. the profit), but cannot incur a liability (as shareholder) beyond his interest in the company as represented by his shareholding. The JSE expresses the rights of a shareholder on their Internet home page as follows:

  • Shareholders may vote at shareholder meetings and general meetings of the company. The company may also be forced by the shareholders to hold a meeting under certain circumstances where they can influence the agenda or voice their opinions.
  • Although not explicitly expressed in the Companies Act, shareholders must be kept informed at all times. A prospectus must be distributed when a company wants to raise capital.
  • Shareholders have the right to receive dividends but this is a legitimate expectation and not a legal right.
  • Shareholders are entitled to expect a high degree of diligence, competence and integrity from the directors of the company.
  • Shareholders have the right to be informed by the company regarding any information or developments that might influence its share price.

The Johannesburg Stock Exchange (JSE) was formed to create an orderly market for the optimal allocation of capital resources in the country. The JSE was initiated in response to among others, the demand for capital to develop the goldmines. The JSE is the 19th largest formal capital market in the world based on market capitalisation and offers a means of raising capital to companies, government and semi-government bodies, acting as a primary market. It also acts as a secondary market where shares and equity securities are bought and sold.

The most common types of securities issued and traded on the stock exchange are the following:

  • Ordinary shares
    Shares with voting power, representing one vote per share, and earning dividends if the profit is sufficient
  • N-shares, A-shares and B-shares
    These shares often have different rights compared to ordinary shares, for instance, different voting power. They often have less voting power than ordinary shares and are issued to raise additional capital without affecting control of major shareholders
  • Preference shares, convertible preference shares, cumulative preference shares, redeemable preference shares and debentures. These are securities normally without voting power but with a preference to a dividend or interest above the ordinary shares
  • Nil paid letters
    When a listed company wants to raise additional capital it may give existing shareholders the first right to buy the new shares issued in proportion to the shareholding. For this right, a letter is issued which is called a nil paid letter (NPL). This letter (representing the right to take up shares) can be sold in the market.

Currently the JSE is housed at 17 Diagonal Street - the heart of South Africa's financial markets, where on 12 December 1978 the historic old hand bell was rung to signify the start of trading at these premises. However, at 4 p.m. on Friday, 7 June 1996, the final bell was rung for the close of trade on the trading floor, thus ending a 108-year era of open outcry trading and giving way to a new era of high-tech computer trading.

Monday, 10 June 1996, saw all trade being conducted on the JET (Johannesburg Equities Trading) system, a system which had been gradually phased in over the previous three month period, since March 1996.

2.2 The structure and role of the JSE

The JSE belongs to and is governed by its members but, through their use of JSE services and facilities, these members are also customers of the exchange. Many of its members also trade in bonds through the bond exchange (BESA) and financial futures through the futures exchange (SAFREX). Traditional options are traded on an OTC basis, although some standardised options have been listed on certain exchanges.

Corporate limited liability membership with ownership by non-stockbrokers was introduced on 8 November 1995, where the member firm is the trading entity and not the individual. Foreigners may also operate as member firms, while most of South Africa's major banks have become member firms of the JSE and can now offer stockbroking services through their branches.

Aspiring stockbrokers must pass the examination of the South African Institute of Stockbrokers, founded in November 1995, and has to have been employed by a member firm for a period of at least six months. There are two categories of membership: practising and non-practising stockbrokers.

Although there is only one stock exchange in South Africa, the Stock Exchanges Control Act (1985) does allow for the existence and operation of more than one exchange, Financial Services Board. There has been talk of establishing regional exchanges as a means for small to medium-sized companies to raise capital, as this cannot be done effectively on the JSE because of stringent listing requirements.

Amendments to the Stock Exchanges Control Amendment Act was approved by parliament in September 1995 and had a profound effect on the functioning of the JSE. The amendments and subsequent restrucEagle Tradersg had an impact on membership (as seen above), trading principles and systems, clearing and settlement, transfer and registration, capital requirements of member firms and the financial structure of the JSE.

The main function of the JSE is the raining of primary capital by rechannelling cash resources into productive economic activity, thus building up the economy while enhancing job opportunities and wealth creation. As mentioned previously, it also acts as a secondary market and liquidity is perhaps the most important objective of any stock exchange. The success with which the primary market fulfils its function of raising new investment capital is, among other elements, dependent upon the liquidity in that market. A listing on the JSE enables companies to raise capital for expansion and for the financing of new business. To the person in the street it represents, in the medium to long term, a means of investment in the corporate companies of a country. The capital appreciation from holding shares over a period of time often exceeds the rate of inflation. For those who are knowledgeable about the performance of selected shares, speculative buying and selling may be appealing, but the risk is high.

2.3 Trading of listed equity

Listed shares are traded through authorised brokers, and settled through the computerised clearing system on the JSE. In terms of the Stock Exchanges Control Act 1985 (as amended), it is mandatory for a client purchasing shares to pay his stockbroker within seven business days after the date of the purchase. (A practice used by stockbrokers on the JSE is to settle on the Tuesday following the deal). A client in possession of shares may request his stockbroker to sell these shares, which the client must deliver within seven days after the date of the sale. In terms of the Companies Act, the buyer must sign a transfer form (see appendix 4 for an example).

This entire manual process is being changed to electronic transactions through the STRATE (Share transactions totally electronic) project. Share certificates will eventually be obsolete and transfer of ownership will be by electronic means.

The first 10 companies on the JSE to switch to electronic transactions will do so by the end of 1998, to be followed by 50 companies per month. The project should be completed by 1999.

In March 1996 the JSE commenced automated trading converting the first group of stocks from floor trading. Using the JET (Johannesburg Equities Trading) system, the structure then changed to

  • A continuous order-driven system with central market principles
  • Dual trading capacity, complemented by member firms voluntarily acting as market makers
  • Fully negotiable brokerage with clients.

The JET system gave rise to significant improvements for investors, listed companies and the JSE itself, through improved transparency, liquidity, security and audit trails which greatly enhance investor protection.

The ease of trading and increased liquidity made the cost of raising capital cheaper.

2.3.1 The JET system

The central order book ("The book") is the corner-stone of, and is managed by, the JET system. The book is accessed via trading work-stations (computer terminals) which are linked to the JET system through a computer network Dealers enter buy and sell orders on the work-stations.

The orders are immediately included anonymously in the summary display of the aggregate of orders in the order book for all dealers to view (see appendix 3). All that can be seen on the screen regarding the bid to buy or the offer to sell, is the number of shares and the price. Neither the name of the dealer nor that of the company appears in the book until the transaction has been concluded.

The order book is divided into a bid side and offer side and organised on the principle of priority where orders, when registered in the book, are ranked in priority of price first and then time within price.

The bid with the highest price is placed on the top left of the order book and the offer with the lowest price at the top right. The system continuously seeks to match the bids and offers, comparing new orders and those in the book to one another and executing trades whenever the terms of the orders match.

When the price of a bid and an offer matches, the system will match the transaction in time order, that is, the deal that was entered first at the same price, is matched first. Dealers are advised immediately of matched trades, and a code number is recorded for client identification purposes.

With the implementation of the new system, the satisfaction rule was introduced, implying in principle that all orders in the order book which are at a better price than the price for any proposed negotiated trade, must be satisfied at their respective bid/offer prices by any stockbroker before the negotiated trade can take place.

The JET principles and trading rules have been developed following principles aimed at optimising investor protection. The system allows for maximum efficiency and equal participation by all players, both large and small.

2.3.2 Single and dual trading capacity

The JSE's rules also allow member firms the choice of dealing in either single or dual capacity:

  • Single trading capacity is where a firm acts only as an agent between the buyer and the seller
  • Dual trading capacity is where a member firm acts as an agent, or on behalf of, or as a principal with a client.

The member firm may therefore sell shares to a client from its own holding of shares. However, the member firm must inform the client of the capacity in which it is acting prior to the transaction being effected.  If no information is provided beforehand, it will be assumed that the member firm is dealing as an agent.

The introduction of dual trading capacity and fully negotiable commissions was made simultaneously with the automation of trading in March 1996.

2.3.3 Purchasing and selling shares

Investors buy shares listed on the JSE through member firms. When a potential investor approaches a member firm, an account is opened and discussion takes place with one of its stockbrokers about the proposed investment. (It is likely that the stockbroker will also advise the investor.) Decisions need to be made about the shares to be purchased and the amount to be invested, taking into account the fundamentals of the share such as the quality of the company, the price/earnings ratio (P/E ratio) of the share, the quality of the company's board of directors, etc.

Shares are normally traded in multiples of 100. Special provisions are made for the trading of odd lots, that is, share quantities under 100. A specialist firm is appointed which administers all odd-lot trading, and this ensures that trades take place at current market values.

On instruction from the stockbroker, a dealer executes the order of the client at the price agreed upon, by entering the order in the book. This order immediately appears on the screens of all other dealers of members as described in section 3.1.

As an alternative to doing the transaction at one given price, the client may have imposed certain price limits within which the dealer must buy or sell the shares, but these limits should be reasonable with regard to time and ruling price (normally the price at which the last transaction was done). From the date of purchase there are seven business days within which to pay for the shares, and a share certificate will follow later. The transfer secretary who records share ownership also issues share certificates. The client will receive an invoice or a note from the broker, with details of the transaction.

Selling shares is almost a reversal of buying shares. The seller may ask his stockbroker to sell all or part of his shareholding at the best price possible or within certain limits. Buying or selling limits are usually set when the client wants to obtain a certain price for the shares and is prepared to wait until this price is met. Sellers hand over their share certificates to the member firm and sign a transfer deed, which allows the shares to be transferred to the buyer. Once the sale is executed, sellers receive the proceeds from the sale within seven working days.

When the order is executed the client will receive a broker's note (see appendix 5) containing relevant details of the transaction and will then be asked to pay for the shares or deliver the shares and sign a transfer deed.

Special kinds of deals are sometimes done on the JSE, two of which are:

  • Bear sales or short sales
    The sale of securities of which the seller is not the owner. The short seller still has to purchase these securities at a later date to be able to deliver the shares to the buyer. Securities are normally sold short when there is an expectation that prices will drop, resulting in the purchase of these securities at a later date at a lower price.
  • Bookover
    A trade where the buyer and the seller do their deals through the same stockbroker. The satisfaction rule applies in this case, stating that bids and offers already on the order book must be honoured before the bookover can take place.

Dependence on paper in the form of share certificates and transfer documents will eventually be eliminated. The first step is the institution of electronic settlements which take place via computer networks and databases, instead of a physical certificate and a cheque being exchanged before a transaction takes place. Share certificates will be kept in a central depository (CD) and registers of owners will be on computer. This means a shorter settlement period (eventually T + 1 - one day after the trade). The JSE, in consultation with other interested parties, is also investigating the implementation of an electronic scrip registry that will initially be facilitated through a central depository but later by means of electronic share registers. This will be known as "share transactions totally electronic" (Strate).

2.4 The listing of a company's shares on the JSE

A public company registered under the Companies' Act and having been in existence for a number of years, may list its ordinary shares on the JSE if the company qualifies under certain requirements. The nature of business of listed companies varies greatly, ranging from mining and industrial concerns through textiles, fishing and entertainment. Closed corporations, partnerships, sole proprietorships and proprietary limited companies are not allowed to list.

There are many different reasons why a company will try to list its shares. By listing on the JSE a company can raise additional primary capital by means of a public issue of shares. Additional capital can also be raised after the first listing by means of a rights issue of new shares to existing shareholders. Companies listed on the JSE tend to receive more coverage in the media, and if this coverage is positive, it could be a means of marketing.

When applying for a listing a company will qualify for one of three possible listings:

  • the Main Board
  • the Development Capital Market
  • the Venture Capital Market.

The listing requirements for the three categories are detailed in the following sections.

2.4.1 The Main Board

The requirements for listing on the Main Board are

  • a subscribed capital, excluding revaluation of assets, of at least R2 million in the form of not less than one million shares in issue
  • a satisfactory profit history for the preceding three years, the last of which had to report an audited profit before taxation of at least R1 million
  • a minimum of 10% of each class of equity shares to be held by the public
  • a minimum of 3000 public shareholders for equity shares
  • the minimum initial issue price of shares to be not less than 100 cents per share.

The JSE may list companies that do not strictly comply with the above requirements, but this will only occur in exceptional circumstances.

To promote the socio-economic development of South Africa, the JSE has introduced the Financial Redevelopment sector to the Main Board, and to promote industrial development in South Africa, the Industrial Development Stage sector was introduced to the Main Board. Financial redevelopment sector

In evaluating a listing of a redevelopment entity, the JSE will have to consider, inter alia, the fundamental principle that the principal objective of the redevelopment entity must be the provision of assistance, whether through investment, loan or other means acceptable to the JSE, to persons, communities or undertakings which, in the opinion of the JSE, are of a socio- economic development nature.

The JSE may admit the securities of a redevelopment entity to listing, subject to whatever conditions it deems necessary which may include requirements that are different from those contained in the listing requirements. One of the aspects that the JSE will look at is whether the applicant's assets consist wholly or substantially of cash or short-dated securities. Industrial development sector

The JSE may list the securities of substantial industrial companies that are in the developmental stage and, accordingly, do not have the profit history required for a Main Board listing.

The applicant should have a subscribed permanent capital, prior to the offering of securities to the public, of at least R20 million, and will have to provide a forecast of future profits/losses during and at least one year after the development stage.

2.4.2 Development capital market (DCM)

Recognising the need to encourage the growth of small to medium-sized businesses and companies that are unable to list on the Main Board, the JSE created the DCM in 1984. While still demanding quality and stability of a DCM company, the criteria to be met are less onerous than those of the Main Board.

It is expected that DCM companies will use the capital raised to expand to a level where they meet the requirements for a Main Board listing.

The principal requirements for a DCM listing include

  • a subscribed capital, excluding revaluation of assets, of at least R1million, in the form of not less than one million shares in issue
  • a satisfactory profit history for the preceding two years (or in exceptional circumstances, a lesser period), the last of which had to show a reported and audited profit level of at least R500 000 before taxation (mineral companies are exempt from this requirement)
  • a minimum of 10% of each class of equity shares in issue to be held by the public
  • a minimum of 75 public shareholders for equity shares
  • the minimum initial issue price to be not less than 50 cents per share.

The creation of and listing on the DCM seems not to have been received well by the business world. Companies tend to wait until they qualify for a listing on the Main Board before listing at all. In May 1998 only nine companies were listed in this section.

2.4.3 The venture capital market (VCM)

To assist companies specialising in venture capital projects (venture capital conglomerates) or single venture companies, the JSE formed the VCM in 1989.

Prior to the submission of an application for listing, the JSE requires a memorandum giving a summary of the nature of the business of the applicant, its modus operandi, its business plans and prospects. If the memorandum is approved, the company may make a formal application for listing.

A single venture company must draw up an analysis of its prospects, based on its market segment growth, competitive analysis and market share. From this, it should present a three year business plan with forecasts of balance sheets, profit and loss accounts and cash flows.

A venture capital conglomerate must have as its dominant business the professional operation of a company which holds and will in future hold a portfolio of investments in ventures, each of which is characterised by the fact that the venture capital conglomerate:

  • has an investment in each underlying venture which is substantially an equity venture
  • is able to add value to each of its underlying venture projects through providing support services and proper financial disciplines
  • has conducted adequate research into the management strength and commercial viability of each of its underlying ventures
  • has drawn up a business plan for the next three years in respect of each underlying venture and of the combined portfolio, with forecasts of balance sheets, profit and loss accounts and cash flow statements.

The principal requirements of a VCM listing include

  • a subscribed capital, excluding revaluation of assets, of at least R500 000, in the form of not less than one million shares in issue
  • the assurance that the entrepreneurs will remain financially committed to the VCM company. Accordingly, the JCE will not list securities held by the entrepreneurs of the VCM company amounting to 75% of their share holdings (as held immediately prior to any marketing of securities in conjunction with the application for listing) for a period of at least two years subsequent to listing being granted that no profit history is required, but the company should, in its analyses of future earnings, indicate credible returns on capital which, on a time-weighted basis, are above average
  • a minimum of 5% of each class of equity shares to be held by the public
  • a minimum of 75 public shareholders for equity shares
  • the minimum initial price of shares to be not less than 50 cents per share
  • the majority of directors and managers to have successful records of achievement in their respective CVs
  • a warning to be issued at the beginning of its prospectus, or pre-listing statement, concerning the speculative nature of investment in such a company.

A company may be de-listed as a result of a take-over or merger, or in the case of a "cash shell" if it has not acquired new business within eight months of becoming a "cash shell" in terms of JSE criteria.

In May 1998 20 companies were listed under this section.

2.4.4 Warrants

Warrants were first listed on the JSE to give the small investor an opportunity to be exposed to expensive shares without having to buy 100 of the physical shares. Normally 10 warrants represent an exposure on 1 share and 100 warrants will thus cost much less than 100 shares. A warrant is a long call or put option on a share or a basket of shares and it will be discussed in detail in the chapter on options (chapter 7).

2.5  Investment and share prices

Initially, the pre-listing statement or prospectus, financial statements and any projected profits are the investor's guide in determining the value of the share.

The share price, from the day of listing, is influenced by supply and demand based on the value which investors place on that equity. Where demand for a share exceeds supply, the price tends to rise. On the other hand, where supply exceeds demand the price tends to fall. The price of a commodity in which the listed company trades, such as gold and oil, also influences the price of that share. The general tendency, particularly where gold is concerned, is for share prices to rise or fall in line with changes in the rand price of gold.

In forming an opinion about the performance of various equities, one should study the most recent interim and annual reports published by the relevant companies. Stockbroking firms have research departments which do extensive research on companies listed on the JSE. They are often able to supply information about the forecast for a company, its share performance in the past and its dividend yield.

A further valuable source of information is the JSE monthly bulletin, which contains current and historical information on companies' shares. The stock market handbook is updated and published twice a year and covers the nature of the business, the names of the directors, share capital information, forecasts and dividend dates, financial statistics and shareholding percentages for each listed company. Various financial newspapers and magazines are available as sources of information.

Some of the factors in addition to the information mentioned above, which should be considered are the following:

  • The specific sector in which the company operates
    In evaluating possible investments an investor must try and determine which sector of the economy will perform best. Having selected a sector, he will then have to select a company in whose shares he wants to invest. To do this properly, he has to consider a host of things, namely the products manufactured or services offered, the financial stability of the company, the quality of management, the competition faced by the company and its overall track record.

Mining shares are, by their very nature, more volatile than other shares, hence the timing of the purchase or sale decision is of the utmost importance. For example, gold shares are affected by the international gold price, quoted in US dollars and the rand/dollar exchange rate.

  • Global and local market trends and influences
    Since the beginning of the new political era in South Africa, the local market has become part of a 24-hour global market. Our stock market is influenced by the trends of the world's major stock markets and by world events.

Domestic determinants such as economic cycles, interest rates, the exchange rate and inflation in the country will most likely also have an influence on the prices of shares on the stock market.

  • Risk and return ratios
    Different shares have different characteristics of risk and return. A new company with a new product carries more risk than an established company with established products. The new company could, however, be the first and only company with the new product and show superb profits for a few seasons if the product is a success in the market.
    An investor must decide how much risk he is willing to take in his investment (known as an investor's risk appetite). By investing in a few companies rather than in one only, the risk will be spread, and would normally be lower.
  • Comparative analysis with the company's competitors
    Other companies in the same sector must be compared with the company in which the investor wants to invest. Comparing financial data and information available from the sources mentioned, the investor will be able to form an idea of the success and prospects of the company relative to its competitors. The relative marketability of the shares in comparison to those of the competitors can also be assessed.

A good indicator towards an assessment of the general opinion of investors regarding the company, is the price/earnings ratio. This ratio expresses the price per share divided by the historical (previous financial year-end) earnings per share. This ratio should be recalculated, using the forecasted earnings per share to make an assessment of the investment's merit.

  • The indicators of the specific company
    The variables concerning the specific company must also be considered, such as the growth record and history of the company. Expectations of future earnings and the quality of management are essential for an assessment of a company. Special factors such as acquisitions, mergers and possible unbundlings must also be considered.


Courses and training in Financial Markets, Instruments, Investments and Derivatives are supplied by the Academy of Financial Markets.  They can be contacted on or via their web site.  New developments in the Financial Markets are incorporated in updates (see index) of this book and can be obtained from The Academy of Financial Markets.