Investment Fundamentals- Shares and The Equity Market

3 min read

SHARES and the STOCK MARKET

Shares/Stocks/Equity can be used interchangeably and it is basically a unit ownership in a company. Thus, anyone who purchases becomes a part owner of the company and is entitled to certain rights- all completely public in a document called Prospectus.

When a company decides to publicly trade its shares for the first time, it’s referred to as IPO (Initial Public Offering).

Now, Share prices change on a periodic-(say daily basis) as a result of information- triggering a demand and supply scenario (how much of a share is demanded and how much of the share can be supplied). An efficient a market will determine how stock prices move.

There are three forms of market efficiency ie. Strong, Semi strong and weak efficiency. “Market efficiency refers to the degree to which market prices reflect all available, relevant information. If markets are efficient, then all information is already incorporated into prices”. Investors and academics have a wide range of viewpoints on the actual efficiency of the market but personally I think most markets are semi efficient.

HOW SHARE PRICES MOVE

For instance, If Company X share is trading at $1 and there is an announcement of a merger or new business opportunity that will significantly increases profitability and note that the (the issued shares)has been fixed, and having heard the news item you’d want to buy X’s shares, you would have to incentivize someone to sell their shares to you as everyone will be chasing after that company X shares . Therefore you will bid at a price higher than the trading price.

Also, if you think based on your analysis (technical or fundamental) that Company X may not do well in the future and want to sell then you should be willing to sell at a lower than market value.

All things being equal that’s how prices should move upwards or downwards. Note that prices in some instances may move not a result of analysis but liquidity needs of investors — someone who wants to just sell their shares and get some cash may sell their shares at a lower price therefore driving the whole market price down. The reverse is also true where someone wants a particular stock such that he/she is willing to pay above the market price. So it may not necessarily be that the company is doing well or not.

MAKING “PROFITS”/ RETURN ON EQUITY

“Profits” are made on equity in two ways: Capital gains/appreciation and Dividends.

You make Capital gains if the stock price increases above your purchase price, say from the $1 to $1.5 then the $0.50 becomes your GAIN. The reverse is also true where the share price can go below your cost. You may sell your shares if the price increases and realize/crystallize your gains. Until you have actually sold the shares we term it as UNREALIZED gains or losses depending on if the price is higher or lower than what you purchased at.

Also, you can earn a return from your equity investments in the form of DIVIDENDS that companies pay from their profits. Typically, in a given year, Company X having made a $10m profit and would declare and distribute $2m as dividends. Dividends are paid per share. For example, it will announce a $0.50 as dividend on each share. Therefore if you have 100 shares you will get $50 as dividends.

WHO SHOULD INVEST IN STOCKS

Anyone with a very long term perspective due to the nature of stocks i.e the price volatility. For example the price of the equity X might drop to say $0.50 and your total investment will be worth $500 or say the price jumps to $1.5 and your investment worth $1500.

Investment in shares are good especially for young people who can have a longer time to realize their gains.

There are also mutual funds that have different stocks as their portfolio for those who want to invest in multiple stocks but don’t know how to go about it.

Contact a licensed broker and get as much information on any stocks you to invest in.

Many thanks for reading and sharing. Questions and comments are welcome.

Desmond Bredu, ACCA.

Tags: investment | share | equity |