What are shares?

Shares are often referred to as equities or stocks and represent ownership in a company. These can be bought in the secondary market via a listed regulated stock exchange or through an Initial Public Offering (IPO) which is also referred to as the primary market.

In the U.S., the New York Stock Exchange (NYSE) and Nasdaq are the major secondary markets available and, on these exchanges, investors can trade stocks they already own or purchase new one’s which are already available on this market.

The value of the shares will typically fluctuate with general economic and industry conditions and with changes in company's profitability. There are two types of return from equities; the share price appreciation and the income companies pay to shareholders (dividends).

Shares carry more risk of capital loss than cash or fixed interest since a company's value can fall due to poor management, change in consumer patters, investor sentiment and other unpredictable factors. On the other hand, well managed companies can achieve high growth in value and earnings over time which can be reinvested back into the business or distributed via dividends to investors. 

 

Why companies issue shares?

Companies issue shares to ‘raise capital’ by selling a part of the company to investors. Some reasons may be in order to develop new products, buy/replace equipment, pay for new inventories or buildings, hire more employees, provide for a merger/acquisition, decrease debt and give company owners greater flexibility. The sale of shares will allow the shareholders a stake in the company's equity as well as a share in its profits, in the form of dividends, and the aptitude to vote at general meetings of shareholders.

 

Types of companies involved

A private company is privately held, which means that the company is owned by the founders, management or a group of private investors. Private companies do not issue shares to the public to raise capital but have turn to private funding (e.g. banks). One of the advantages of privately held firms is that these do not need to disclose annual/quarterly statement to the regulator and the general public.

A public company, on the other hand, is a company that has sold all or portion of itself to the public via an Initial Public Offering (IPO). This means that shareholders have claim to part of the company’s assets and profits. Public companies shareholding trade on the stock exchange and are obliged to disclose financial information to the regulator and the public on a constant basis.

 

Types of Shares issued

1. Ordinary shares

Ordinary shares are the most common type. They carry one vote per share and they entitle the owner to participate equally in the company’s dividends. If the organisation is wound up, the proceeds are again allocated equally. Ordinary shares carry voting rights but rank after preference shares with regards to rights to capital, in the event that the business is wound-up. Ordinary shareholders can be allocated dividend only if it is declared by the company. Some companies might decide to keep profits generated in the business in the form of 'retained earnings' for future use.

2. Non-voting shares

Non-voting ordinary shares usually carry no right to vote and no right to attend general meetings. These shares are usually given to employees so that remuneration can be paid as dividends for the purposes of tax efficiency for both parties.

3. Preference shares

Preference shares entitle the owner to receive a fixed amount of dividend every year. This is received ahead of individuals that hold ordinary shares. It is also usually as a percentage of the nominal value (the value stated when the shares were issued).

4. Redeemable shares

Redeemable shares are issued on the terms that the company will/may buy them back at a future date. This is either fixed or, set at the director’s discretion. It’s usually done with non-voting shares given to employees so that if the employee leaves, the shares can be taken back at their nominal value.

 

How are shares traded?

Following the IPO (initial public offer), the shares become public and begin to be listed on the stock exchange. The stock exchange is a place where buyers and sellers meet and decide at what price to exchange the share. Some exchanges are physical places, where shares are exchanged in a sort of arena called "trading floor". Nowadays, stock exchanges are becoming more like virtual places, where exchanges are made and recorded electronically, thanks to the many trading platforms available on the market.

The stock market is a secondary market, which is a place where stock owners can interact with potential buyers. It is important to understand that companies listed on the stock exchange do not buy and sell their shares daily (they can buy back their shares, do what is called "buy back", or issue new shares, but these are extraordinary transactions) so when someone buys a share on the stock exchange, he is not doing it directly from the company, but he is doing it by buying the share from another shareholder who has decided to sell his shares. Likewise, when we sell a stock on the stock exchange, we are not selling it to the company itself, but we are selling it to another investor. The price of shares on the stock market is decided by an auction process, where buyers and sellers place their bids. The "bid" price is the price at which an investor would like to buy, the "ask" price is the price at which someone would like to sell. When the two prices coincide, the operation is performed.

In some exchanges, operators called ‘market makers’ or ‘specialists’ are available. Their task is to guarantee a "bid" price and an "ask" price, in order to encourage investors to place their orders.

The spread is the difference between the "bid" price and the "ask" price.  The narrower (wider) this price difference is the greater (smaller) the liquidity on that particular stock.

 

Online data relevant to a stock

When we are looking at a stock, various online sources will provide us with a lot of different data sets that all have a particular meaning. Below is a screen shot for Apple shares taken from yahoofinance.com.  Listed further below is a brief description of some of the items shown on the screen:

 

Apple Inc. : official company name for the relevant stock

Ticker (AAPL)– ticker of the shares traded. Every company which trades on the stock exchange has a unique identification symbol for ease of reference. A stock’s ticker may consist of letters, numbers or a combination of both.

Price date: Shares, for the majority of them, are traded during normal trading hours (which in the US is from 9:30am to 16:00 pm). There is also the pre-trading (or after-hours trading) which is the period of time investors can trade outside normal hours through electronic exchanges (In the US this is between 4:00 pm and 8:00 am). After hours trading is mostly available to institutional investors however it become more popular over time when more investors embraced electronic trading and financial markets are more globalised. There are of course various risks using after hours trading which include less liquidity, wider spreads, higher volatility and harsh competition for individual investors as they must competitor against large institutions.

Price data: Normally online sources will quote the latest/current price, the opening price (for the day or latest) and the closing price (for the day or latest). One will also find the 52 week low/high price which is basically the range of the latest highest/lowest prices during the last 52 weeks.

Volume: the number of shares that changed hands during a given day. The average volume of a security over a longer period of time is the total amount traded in that period, divided by the length of the period.

Market Cap: This is the total market value of all of a company’s outstanding shares. This is calculating by multiplying the current price with the total number of shares outstanding. This is a very quick figure to identify the size of a company.

P/E ratio: The price/earnings ratio (P/E) is the ratio of a company's stock price to the company's earnings per share. The ratio is used in valuing companies. The ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends

EPS: The earnings per share (EPS) tells you how much money the company is making in profits per every outstanding share of stock. The higher the EPS is, the more money your shares of stock will be worth because investors are willing to pay more for higher profits.

Dividend Yield: this is a financial ratio that indicates how much a company pays out in dividends each year relative to its share price. It is calculated by dividing the annual dividends per share by the price per share.

Ex-dividend date: When you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend.

 


Other Categorisations of Shares

Equities can also be classified into one or more of the following categories:

Growth stocks have earnings growing at a faster rate than the market average. They rarely pay dividends and investors buy them in the hope of capital appreciation. A start-up technology company is likely to be a growth stock.

Value stocks have a low price-to-earnings (PE) ratio, meaning they are cheaper to buy than stocks with a higher PE. Having a low PE ratio may reflect the fact that they have fallen out of favour with investors for some reason. People buy value stocks in the hope that the market has overreacted and that the stock’s price will rebound.

Market Capitalization: Shares can also be categorized by the size of the company, as shown in its market capitalization. There are large-cap, mid-cap and small cap stocks. Large-cap stocks tend to be the lowest risk relative to the equity market as a whole as they have a lot of shareholders and are extensively followed and researched amongst brokers, investors, media, competitors and regulators. Medium sized companies can be valued from around €500million to €5 billion and offer greater risks with potentially greater reward than large cap stocks. Small sized firms can have a value as little as €5 to €10million. They offer the most potential volatility and are likely to be less diversified since many will be a niche business, and some even offering a single product.