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Investing basics part 1: introduction to shares

If your New Year’s resolution is to learn more about investing, check out Wise-owl’s investing basics series. In part 1, Simon Herrmann provides an introduction to shares.

Is there a difference between shares, stocks or equities? How is the price of a share determined and how many shares are available? Do I have responsibilities when I own a share? What are my rights?

If you are an experienced investor you probably know most of the answers to these questions but if you are just at the beginning of your investing journey, you should first get familiar with the concept of shares. Let’s break it down.

 

What are shares, stocks or equities and how is the price determined?

Is there a difference between shares, stocks or equities? The short is answer is: no. The terms share, stock and equity refer to the same thing, which – in the context of investing - mean a ‘part’ or ‘piece’ of a business. For the sake of this article, we will exclusively look at publicly listed companies.

If a company is publicly listed, the business is split in numerous ‘shares’ which belong to different shareholders. The individual shares can be bought and sold and are usually traded on a stock market. There are a number of share markets in Australia but the largest and most known stock market is the Australian Securities Exchange, often referred to as ASX, based in Sydney.

For example, company ABC has issued 100 shares which are valued at $1 each so the total value of business ABC – also known as the market capitalisation – is $100. The total value of the business is determined by multiplying the stock price and number of shares

If investor 1 wants to buy 10 shares of company ABC, he or she has to pay $10 to the seller and once the transaction is completed he or she owns 10% of the company. Keep in mind that most companies issue millions of shares so individual investors generally own a very tiny fraction of the company.

The value of each individual share is based on supply and demand and determined by the market. For every trade to take place there has to be a buyer and a seller which agree on a price. Put simply if the quantity of buy orders is greater than the quantity of sell orders, the price of the share goes up and vice versa. There are many factors which affect the share price of a company but that’s beyond the scope of this article. Also please note that the number of shares on offer as well as the price is different for every company.

 

Buying a share means owning a part of the business!

In 2017 it is very easy, quick and cheap to buy shares as you can simply open a share trading account with e.g. nabtrade in just a few clicks and buy or sell shares online. But please consider the following: If you buy a share or several shares of a company, you practically own a part of the business.

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 have sufficient knowledge about the business that you are about to invest into and that it is in line with your investment objectives and personal values.

 

Rights and responsibilities of shareholders

Owning a part of a business also comes with responsibilities and rights. The first responsibility is the financial liability which means you have to pay the price of the stock at the time of purchase, which is determined by the market as explained above. Once the transaction is complete, ordinary shareholders have voting rights, the rights to receive dividends and franking credits (if these are paid by the company), the right to participate in further capital raisings, and - in my opinion – the responsibility to stay abreast with business developments.  

Ordinary shares generally come with one voting right for each ordinary share which means the holder is entitled to vote at the Annual General Meeting (AGM) of the company and also receive dividend payments if applicable. The more shares you own the more votes you have and the greater the dividend payment.

 

How to buy and sell shares?

An investor must use a stock broker to buy or sell shares on the ASX. The broker acts as an intermediary between investors and the company and its main task is to facilitate the transaction. Brokers are often split into two groups which are discount or online brokers and full-service brokers. In order to buy or sell shares, the investor has to open and fund an account with the respective broker.

 

Is there a fee for buying shares?

Usually yes. The fee for buying or selling shares is commonly known as ‘brokerage’ fee and is charged by an agent – the broker - to execute the transaction on your behalf. The fee may vary depending on your broker, the size of your position or any other relevant reason. The fee can either be a flat fee or a percentage relative to your position size.

The key points to take away from this article:

  • The terms share, stock and equity are synonyms and refer to a part of the business
  • Investors can buy or sell shares of publicly listed companies through a stock exchange such as the ASX
  • The price of a share is determined by the market and the number of shares available varies for each business
  • If you buy shares you own a part of the business
  • Shareholders have the right to vote, receive dividends and participate in future capital raisings. Shareholders are encouraged to follow the developments of the company they own
  • Shares are bought and sold through brokers and a brokerage fee is charged for each transaction

In the next part, we will talk about how to build a share portfolio and what you should consider before buying stocks.

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