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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.