Before one decides to invest in shares it is important to understand what shares actually are. As simple as this question might sound, you should not invest if you are not entirely aware of what shares are, what you are doing and what the risks and responsibilities are if you own shares. Let's break it down.
What are Shares?
Buying shares in a company provide the shareholder with equity in that company. Because you own a part of the company, as a shareholder you're are entitled to a portion of the profits it makes, and these are paid out as dividends. This dividend income can be one of the ways in which shares generate returns for their holder(s).
Shares are issued by the company in question and sold to investors for cash in an 'initial public offer' or 'float'. After this initial sale, shares are then bought and sold on the stock market, unless bought back by the company at a point in the future.
If someone refers to shares, stocks or equities he is referring to the same thing. These three expressions are synonyms and in the context of investing refer to one "piece" or "share" of a company.
The Number of shares
- Authorized shares comprise the number of shares a company's board of directors may issue.
- Issued shares comprise the number of shares that are actually given to shareholders and counted for purposes of ownership.
- Authorised shares that can be sold 100,000
- Actual Issued shares 80,000
- There are still 20,000 shares in the company that the Board CAN issue, but have not yet.
Because shareholders' ownership is affected by the number of authorized shares, shareholders may limit that number as they see appropriate. When shareholders want to increase the number of authorized shares, they conduct a meeting to discuss the issue and establish an agreement.
When shareholders agree to increase the number of authorized shares, a formal request is made to the state through filing articles of amendment.
The Types of shares
There are two main types of shares – common shares and preference shares. Both represent a shareholder owning a part of a company, but function in slightly different ways and give different rights to their holders.
Most companies issue ordinary shares (also known as common stock). The stock may benefit shareholders through appreciation and dividends, making common stock riskier than preferred stock. Ordinary Shares also comes with voting rights, giving shareholders more control over the business.
In addition, certain common stock comes with pre-emptive rights, ensuring that shareholders may buy new shares and retain their percentage of ownership when the corporation issues new stock.
Preference shares do not confer voting privileges by default to their owners and tend to appreciate in value at a slower rate compared to ordinary shares.
One of the key advantages is that they usually come with set payment criteria which guarantees them (subject to certain exceptions) regularly paid dividends.
Preference shareholders are also prioritised ahead of ordinary shareholders; all preference shareholders must be paid before any ordinary shareholders can receive dividends. The same goes for instances of insolvency/liquidation.
Company goes bankrupt
- $100,000 in assets can be sold to repay shareholders
- Preference shareholders amount to $80,000 in the value of their shares
- They get the first $80,000 and the remaining $20,000 is split between all ordinary shareholders
If you buy a share or several shares of a company, you practically own a part of the business. Instead of starting your own business, you can simply buy into an already established business.
If the company is publicly listed on the stock exchange you can simply buy a certain portion of that company and therewith become an investor.
Ordinary shares generally come with one voting right for each ordinary share. The holder is entitled to vote at the Annual General Meeting (AGM) of the company and receive dividend payments if applicable.
The more shares you own the more votes you have. Preferences shares may have voting rights attached too, however, this might depend on the terms of the shares.
Buying and Selling Shares
Public vs Private Companies
It is considerably straightforward to buy shares in a publicly listed company which is listed on any of the major stock exchanges. Those companies have raised proceeds in the initial public offering (IPO) and are now trading on the secondary exchange, in other words on the stock exchange.
These companies have deliberately gone public and are now offering shares of their business to the general public. Those companies have a quote market value and especially large companies have high liquidity which allows investors to buy or sell shares instantly.
If the company is not publicly listed, you will not be able to buy shares on the stock exchange, however, there might still be ways to invest in the business privately.
Raising money from private investors is a common way to raise capital if the company does not intend to list on the stock exchange for whatever reason that might be. Some companies allow you to simply buy into the company or alternatively offer asset purchases or entirely foreign ownership.
Generally, the investment horizon for private investments is longer than for public companies, as they are rather illiquid and terms and conditions need to be determined before any transactions can be made.
As there are fewer investors, the influence on the direction of the business might potentially be greater.
For identification purposes, each stock that trades on a stock market (also known as an exchange) is allocated a three (or sometimes 4) letter code. For example Canopy Growth's US ticker on the Nasdaq is CGC and on the Toronto Stock Exchange, it is WEED.
There are two types of trading or investment timeframes. The first is trading, where you are buying and selling shares with some sort of regularity. This could be a couple of times a year, or even daily (known as day trading).
The second type is Investing. This means buying shares and then holding them for a period of time.
Trading shares rather than investing in them essentially means that you're not looking to hold onto any shares you buy for the long-term – you're trying to profit off a short-term change in their value, sometimes as short-term as days, or even hours.
While this can be inherently more risky than holding onto shares for the long-term, it can occasionally result in quick money for the canny investor. That being said, it can also be an easy way to lose money if your shares of choice go down in value rather than up.
That's why it's important to not just jump in and start buying shares as soon as you've set up your trading account. Watch the market for a while, and keep an eye on any stocks you're interested in.
That way you'll have a good idea of when they're up and when they're down.
Investing in shares for the medium or long-term can mean some investors benefit from what many perceive to be the main strength of shares and the wider stock market – over a long enough period, the market generally tends to go up.
Time in the market can create significant returns.
Tiny amounts invested a century ago would be worth a great deal more now, and this chart from the Australian Securities Exchange (ASX) demonstrates that if you'd put a single dollar into Australian shares in January 1900, it would be worth nearly $300,000 now!
The good, the bad and the Ugly
In times of computers, high-speed trading and virtual transactions, many investors forget that they actually own a part of the business and that it is more than just a digital number on the screen.
If you decide to invest in a business, we generally recommend that you know everything about the business that you are about to invest in and that it is in line with your investment objectives.
A short-term trader might see this differently as he simply looks for chart patterns such as support and resistance levels and potentially doesn't care what the business does and what the fundamental future outlook is.
Share values can be volatile and can fall dramatically in price, even to zero.
Owners of ordinary shares are generally the last in the line of creditors if a company fails and there may be no chance of getting any money back.
Sleep at night factor
While daily fluctuations in price are to be expected, investors can often feel a degree of stress from short-term volatility and bear market conditions.
Unexpected events which are outside of your control, such as company-specific bad news, a change in government policy or natural or man-made disaster can seriously affect share prices.
Lack of knowledge
Your lack of knowledge as a new investor may be considered a risk initially.
There are many reasons why someone would choose to buy shares of a company. The most common reason is to buy a share is the expectation of capital gain in the future.
That means you buy a part of the business as you hope the value of the business – and therefore its shares – increase in value over time. In this sense, the capital gain can either be achieved through capital growth of the investment or through dividends.
The benefits of buying shares will vary depending on your investment goals, and whether you're wanting to trade or invest.
Ordinary shares are the most common type of shares and the full name is fully paid ordinary share or FPO. You may see this abbreviation after the name of the share when you search on your broker's website.
Generally, when investors talk about shares, you can assume that they mean ordinary shares.
With some companies, there can be two classes of share and usually, they are called A and B. Generally, the different classes come with different voting rights.
As an investor, it is important to know what class of shares you are buying when you make an investment in a stock.
Preference shares are generally superior to an ordinary share in some way, usually because they have first preference or right to a dividend.
Preference shares generally don't have voting rights.
Some preference shares are convertible, that is, they can be converted to ordinary shares at some stage in the future. These type of shares are also known as hybrids.
Contributing shares are also known as partly paid shares. These shares are usually issued, such that part of the price that is payable immediately and a balance is then due by installment payments at a future date.
If the company is a no liability company the shares can be forfeited instead.
Contributing shares can be bought and sold on the ASX like any other share, with the future amount owing being carried over to the new owner.
Recently, a number of investors and traders were caught out when they bought shares in a company that had dramatically fallen in value to less than a cent, hoping to make a quick profit.
Unfortunately, the shares they bought had a $1 installment due within a short time frame. A lot of people faced financial ruin because of the large numbers of shares they had bought.
This clearly brings home the message that it is imperative that you know exactly what it is you are buying.
Company issued options
Company issued options are options issued by the company that gives the holder the right to acquire a certain number of fully paid ordinary shares at a stipulated price at any time in the future up to the expiry date.
While a company issued option can be listed on the exchange, it does differ slightly from other options you may see.
If you exercise the company option, new shares are issued and the company collects the full agreed price of the share from the option holder.
If this makes sense to you, then your next step should be to better understand the actual markets themselves. You are now one step closer to entering the Green Rush as an educated investor. Knowledge is power in the investment game, and the more you know and the more you understand – the better off you will be.
Now, back to those markets…