Stocks
and shares form a large and valuable part of many people’s investments for the
future; even people who have not invested directly in shares are probably
involved in the share market to some extent as all Pension Funds, Unit Trusts
and most other investment schemes depend on Stock Market performance for their
value.
Although
the terms ‘stock’ and ‘share’ have historically signified two completely
different investment instruments, their modern usage is interchangeable and
implies the same financial investment…that of a ‘share’…we will also adopt this
convention: but what exactly is a share and why would you buy one?
When
a company first starts up, it will very likely not possess all the money that
it needs to fund its activities. A company’s start up costs might include
things such as buying stock (in this case ‘stock’ refers to raw materials and
goods to sell on), buying furnishings and equipment for its offices and working
capital.
The
company at this point would have two choices; get a Bank loan to fund these
things, or ask private investors to lend them the money. A Bank will often
willingly lend the money as it will charge interest on the loan; so this is an
expensive way for a company to fund itself. Utilising the other option, private
investors buy shares in the company; they become shareholders (effectively
joint owners) of the company and the company uses the money raised from the
shareholders to fund its activities; this is a ‘cheaper’ way of funding
companies at their inception…but what’s in it for the shareholders?
Well,
two things; dividends and growth of capital.
At
the end of each financial year, a company will assess its performance and
calculate how much profit it has made that year. Every company will then
typically invest some of this profit back into itself for its ongoing needs and
the rest of the profits will be distributed amongst the owners of the
company…its shareholders. This annual payment is called the ‘dividend’ and many
investors use the dividend from their initial share purchases to provide
themselves with a regular income. The dividend is declared in terms of ‘pence
per share’…obviously, the more you invest (i.e. the more shares you have), the
greater your annual return.
The
more successful a company becomes, the greater its profits and thus the greater
its annual dividend. At this point, more people will want to buy the company’s
shares (to avail themselves of this high rate of return) and the finite amount
of shares will rise in value due to the laws of supply and demand. This gives
the original investors a second ‘bonus’, as if they sold their shares, they
would get more than they originally paid and make a gain on their capital.
This
potential capital gain is the second reason people invest in shares; they
either speculatively, or through research, identify companies who they think
will do well (and thus, whose shares will rise in price) and buy those
companies’ shares on the hope of a capital gain in the future. Of
course, shares, the stock market and investment strategies are a science in
themselves, but this basic introduction to shares, forms the basis of all
investment and market strategies.
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Stocks & Shares Advice