Overview: The purpose of this whitepaper is to educate readers about a flaw in our market structure, that causes income-producing securities to trade “Dirty." Dirty security pricing causes investors to pay inflated values for income-producing securities and then...

The purpose of this article is to prove that, at least for income-producing securities, the stock market is NEVER efficient. The evidence of an inefficient stock market is a provable fact, and this article should change investment behavior. The entire market for income-producing securities is overvalued – but it gets worse, as we will discuss. The reason markets are not efficient when pricing income-producing assets is a result of the accounting treatment of dividends and capital gains used by investment funds and individual companies in order to comply with the last holder of record income distribution system. The last holder of record income distribution system is a perilous model which I have written about extensively in other blogs and research papers.

Black-Scholes is a pricing model that is used to determine the fair value of a put or a call, given certain variables. Armed with this pricing model, an investor can determine if an option is priced appropriately and then decide to invest, or not, on that basis.

This essay will introduce the FairShares FairValue Index. This index is similar to Black-Scholes in that it provides a pricing model that is the most accurate method available to price an income-producing security on any given day of a payment period. But it is also much more than that. In addition to a pricing model, the FairShares FairValue Index can tell us:

- How much money an investor will lose as a result of buying a dividend.
- How many fewer shares an investor will purchase as a result of inflated asset values that are a product of accounting for dividends as assets, instead of what they are – liabilities.
- How much additional and unnecessary tax will be paid by an investor who has owned a security for at least 60 days but less than a year and wishes to sell the security.
- How much annual yield an investor will forfeit by purchasing a security with a dividend premium.
- An investor can determine the fair value of any income-producing asset by discounting the dividends from the security’s value. This is needed for more accurate security valuation and portfolio management.

If the goal of an investor is maximizing their wealth, we believe that the FairShares FairValue Index should be analyzed before making any investment of capital.

The mission of any market should be to maintain fair, orderly, and efficient markets. Currently, and especially when it comes to income-producing securities, the market is not pricing these securities as efficiently as possible. This is a result of the last holder of record system which causes investor losses. This system has been in place as long as the founding of the U.S. Securities and Exchange Commission in 1934. It’s time for a change. FairShares has developed the systems and methods to fix this pricing problem. Using our technology, we can revalue income-producing assets in a manner that is fair and does not cause investment losses. Our technology, when applied, makes markets efficient and allows investors to keep more of what they earn.

They say that sunlight is the best disinfectant. For that reason, I have decided to disclose some of our intellectual property to the investment community such that investors can take reasonable steps to avoid losses that are incurred each time they participate in the stock market.

**First, a Word of Estimating Capital Gains**

Unfortunately, there is no way to estimate the accrued capital gains embedded in a security. Investment funds usually publish capital gain values in the 4^{th} quarter of the year. Before you make an investment, I recommend that you call the investment fund you wish to buy as ask them to provide you an estimate of the capital gains as a percentage of the net asset value (NAV). Next, you will want to add that percentage to the result of the FairValue Index calculations below. Combining these two will give you the total amount of realized income that is included in the NAV, that you will end up purchasing. This amount will be subject to unnecessary taxation and result in investor losses. Capital gains can be classified as long-term or short-term and have different tax rates associated with them. Be sure to apply the applicable tax rates in each of your calculations.

**How to Calculate Investor Losses Prior to Purchasing Investment Funds **

The first step in calculating the FairValue Index requires us to understand how much dividend premium has been accumulated into the net asset value, or the price, of a security. The dividend premium is the sum of the accumulated dividends, interest, and capital gains that the security has collected from its underlying holdings. These dividends are treated as assets, pushing up the value of the security beyond what it is worth. Calculating a dividend premium can be done in two ways. The first way is to determine the exact amount of dividend premium that is contained in the securities price. Determining the exact dividend premium can be complicated and an investor may not have access to the information and data needed to calculate this method accurately. The second way to calculate the FairShares FairValue Index is to estimate, using a straight-line method, the dividend premium that has likely accumulated to the value of the security.

For efficiency purposes, we recommend that investors estimate the dividend premium using the FairValue Index equation below. Should an investor want a more accurate calculation of the dividend premium, they can reference the blog found HERE to determine how to calculate the real-time dividend premium contained in an index fund.

The equation below is used to calculate the FairShares FairValue Index formula. The FairShares FairValue Index calculates the current estimated dividend premium embedded in the price of a security as a percentage of the security’s value.

*Where:*

*D = Total estimated upcoming dividend per share in dollars**T = Total number of time intervals in payment period**N = Number of time intervals elapsed since the beginning of the payment period or the previous ex-dividend day (i.e., how many time intervals have passed since the beginning of the payment period – for example the 45th day of a 90 day quarter)**P = Current price of the security*

Let’s discuss this equation. The purpose of this equation is to provide the investor with an accurate estimate of the percentage of the security’s price that represents the accrued dividends. As we have discussed, you NEVER want to buy a dividend. Therefore, you want to invest when the result of this calculation is minimized.

What is a time interval? FairShares uses time intervals to allocate income. A time interval can be any unit of time that the user wishes. The shorter the time interval, the more accurate or real-time the calculation becomes. For example, if you are using the FairShares FairValue Index to understand the actual value of a single stock, using a time interval of one day, will give you a more accurate representation of the dividend premium when compared with using one week as your time interval.

Essentially what we are doing to calculate the FairValue Index is dividing the known or estimated upcoming dividend by the total number of time intervals in the payment period. Then we multiply that quotient by the number of time intervals elapsed since the beginning of the payment period to determine how much of the total dividend has been accrued to date. Said another way, we are multiplying the dividend per time interval by the total number of time intervals that have passed since the beginning of the payment period to calculate the total accrued dividend. Lastly, we divide that product by the price of the security to arrive at the dividend premium as a percentage of the security’s value.

It should be noted that you can rearrange the FairValue Index and any of the equations below in many different ways and come up with the same answers. All potential combinations are the intellectual property of FairShares, Inc. For example, the FairValue Index formula can be shortened as follows:

**The FairShares FairValue Index**

*Where:*

*N = Number of time intervals that have passed since the beginning of the payment period or the previous ex-dividend day**T = Total time intervals included in the payment period**Y = The estimated yield of the security for the current payment period as a percentage*

Now that we have established how to calculate the FairValue Index, we can use the FairValue Index as a component in each of the equations below to calculate the various adverse outcomes of buying income-producing securities.

**To Calculate Investor Losses Associated with a Purchase of Income-Producing Securities Use:**

*Where:*

*FVI = FairValue Index**I = Investment amount in dollars**R = Investor’s combined state tax + federal tax + Net Investment Income Tax (if applicable). Use ordinary income rates if you will hold the security for 60 days or less prior to the upcoming ex-dividend day or if the distribution is considered ordinary. Otherwise, use qualified state + federal income tax rates.*

**To Calculate Investor Losses when Selling a Security Held for at Least 60 Days, but Less than a Year Use:**

*Where:*

*FVI = FairValue Index**S = Value of the securities that will be sold in dollars**O = Investor’s combined Ordinary state tax + federal tax + Net Investment Income Tax (if applicable)**Q = Investor’s Qualified state + federal Income tax rate**+ Net Investment Income Tax (if applicable)*

Investors who own a security that pays qualified dividends are subjected to short-term capital gains tax when they sell a security it owned greater than 60 days but less than a year. Short-term capital gains are generally taxed at twice the rate when compared with qualified income. For more information on how and why this process happens, see THIS blog.

**To Calculate an Investor’s Diminished Buying Power as a Number of Shares Use:**

*Where:*

*FVI = FairValue Index**I = Investment amount in dollars**P = Current price of the security*

This equation shows you how many additional shares you could purchase if the income-producing security you are purchasing was valued appropriately – with the realized income accounted for as a payable liability.

**To Calculate the Yield in Dollars that an Investor will Forfeit by Buying a Dividend Use:**

*Where:*

*FVI = FairValue Index**I = Investment amount in dollars**P = Price of the security**AD = Annual Dividend in dollars (quarterly dividend * 4) or (monthly dividend *12)*

Because of inflated security values, investors buy fewer shares. Because investors by fewer shares, they earn fewer dividends and thus realize a lower yield.

**To Calculate the FairValue of Any Income-Producing Security Use:**

*Where:*

*P = Price**FVI = FairValue Index*

This formula can be used to determine the ACTUAL value of an income-producing security by calculating the securities value minus the accrued income.

**Conclusion **

Disclosure of a fund’s accrued dividends and capital gains is necessary so that investors can attempt to minimize their losses and maximize their buying power when purchasing or selling income-producing assets.

Better yet, investment funds can adopt FairShares’ technology and none of the formulas mentioned above, or the required disclosures of embedded dividends and capital gains, will be relevant or needed. Investors losing money each time they invest in income-producing securities should not acceptable. By adopting FairShares systems and methods, fund managers will be able to provide more efficient pricing of their investment funds and eliminate these investor losses.

Help us educate the investment community on the benefits of “Clean” security pricing.

Follow us on Twitter @BuyFairShares as well as on LinkedIn.

## Author

#### Jeremy Roseberry

CEO