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Shares


What are they?

Shares provide a way for companies to raise money and for investors to take stakes in companies. Take a look at the example below.

Suppose you own a company manufacturing widgets. In order to make the business more successful you need to build a new factory at a cost of £1 million. Trouble is, you don't have this money. You could try and borrow from a bank, but they want a high rate of interest in return. Another option is to try and raise the money from investors, giving them a share of your company in return. If the company is worth around £2 million (called 'market capitalisation'), you could sell half of it to investors as 1 million shares priced £1 each (you keep the other million shares). This means the investors are entitled to receive half the company's future profits, which you pay out every year as a 'dividend'. They can also have a say on how the company is run by voting on important decisions at an annual meeting.

Shares A few years later business is booming and the company is worth £4 million. This means the investors' shares are now worth £2 each and they've had the benefit from receiving dividends each year, not a bad return! However, had your company gone bankrupt then the shareholders would have lost their whole £1 million investment, so buying shares is not without risk.

What happens if an investor wants to sell their shares or someone else is really keen to invest in your company? If your company's shares are quoted on a stock market then anyone can buy and sell those 1 million shares in your company as they please, they simply have to agree on a price.

The challenge as an investor is spotting those companies whose share price is likely to rise.


Ways to get a return

When you own shares there's two ways to get a return, a rising share price and dividends.

Share priceDividends

Share Price The share price is simply the price at which you can buy and sell shares in a company, usually on a stock market. The price is determined by what other investors are prepared to pay for the share. If there's more buyers than sellers then buyers will have to pay more to encourage more sellers, pushing up the share price. If there's more sellers than buyers then sellers will have to cut their asking price to encourage more buyers, causing a fall in the share price.

When you buy and sell shares there's difference between the buying ('offer') price and the sale ('bid') price. For commonly traded shares it's usually minimal, less than 1%, but for less frequently traded shares it could be 10% or more. The reason for this 'spread' is that there's stock exchange 'market makers' in between the buyer and the seller, the spread is their cut.

The overall value of a company, its 'market capitalisation', is calculated by multiplying the share price by the number of shares issued.

Over a long period of time, a company's share price should reflect the company's profitability and the dividends it pays. However, over shorter periods there's many events that can cause share price movements, common ones include:

  • If markets fall due to general bad news, a company's share price might fall even if it's unaffected by the news.
  • A company's share price often rises if it's believed to be a takeover target, i.e. someone might want to buy all the shares.
  • If a company is involved in any sort of scandal its share price usually suffers.
  • If analysts and pundits are keen on a share then demand tends to increase, pushing up the price.

What's to stop you from buying a share just before a dividend is paid and then selling it shortly afterwards, so you profit from a year's worth of dividend income by owning the shares for just a few days?

When a company announces its dividend it also announces an 'ex-dividend' date, dividends are only paid to whoever owned the shares before that date (typically a few months before the dividend is actually paid). As you'd expect, the price of the shares falls by around the amount of the dividend on the ex-dividend date as investors buying then won't receive the imminent dividend.

A company might decide to payout a dividend as extra shares, rather than cash. This is known as a 'scrip' dividend. However, because this normally increases the amount of shares in issue it could reduce the value of existing shares.

How can you gauge the likelihood a company will continue paying the current level of dividend, or even increase it? The 'dividend cover' ratio is one way of doing this. It's equal to the profit after tax divided by the total dividends paid out. A ratio of three or more is usually considered safe, less than 1.5 could mean a cut is on the horizon.

Companies will large cash reserves are more likely to pay consistent dividends than those without, as there's a higher chance they can afford to maintain dividends during periods when profits fall.


What types are there?

There are three main types of share:

OrdinaryPreferenceConvertible

These are the most common type of share. Ownership gives you a share of a company's dividend (after preference shareholders have been paid), the right to attend the company's Annual General Meeting and the right to vote on issues affecting the company. You also own a share of the company's assets, but you'll be bottom of the pile in terms of getting getting any money back if the company goes bankrupt.

The big potential advantage of ordinary shares is that they benefit from rises in company profits, whereas preference shares do not. Of course, this means you could also suffer if profits fall.


Stock markets

Shares in companies are usually traded on stock markets. Stock markets provide a way for buyers to find sellers (and vice-versa) and determine the market price for a share. This makes it simple and quick to buy and sell shares, as well as checking their current market value.

Not all companies are listed on a stock market. Some companies, especially smaller ones, are privately owned, meaning it's impossible to buy shares unless one of the owners decides to sell you some.

You can track the general movement of stock markets using 'indices', which measure the performance of a stock market either overall or a specific part.

Indices may be 'weighted' or 'unweighted'. Unweighted means each company included in the index makes up an equal share (or 'weight') of that index. Weighted means that a company's weight in the index is based on either their share price (price weighting) or size (market weighting). Under a market weighted index a large company will therefore have more influence on the index than a smaller one.

There are many stock markets and many indices per market. The table below shows some of the largest.

Stock Markets & Indices
Country Stock Exchange Companies Listed (approx) Trading Hours Index Weighting Type
UK London Stock Exchange (LSE) 1,000 08:00 - 16:30 FTSE 100 market
UK Alternative Investment Market (AiM) 1,600 08:00 - 16:30 FTSE AiM market
US New York Stock Exchange (NYSE) 3,900 09:30 - 16:00 Dow Jones Industrial Average price
US Nasdaq 3,200 09:30 - 16:00 Nasdaq 100 market
Japan Tokyo Stock Exchange (TSE) 2,300 09:00 - 15:00 Nikkei 225 price
China Shanghai Stock Exchange (SSE) 900 09:30 - 11:30
13:00 - 15:00
SSE Composite market
Hong Kong Hong Kong Stock Exchange (HKEX) 1,000 10:00 - 12:30
14:30 - 16:00
Hang Seng market
Germany Frankfurt Stock Exchange (Deutsche Börse) 900 09:00 - 17:30 DAX 30 market
India Bombay Stock Exchange (BSE) 4,900 09:30 - 15:30 BSE Sensex market

How can I buy shares?

You can buy shares very easily through a stockbroker. The most convenient (and cheapest) way is by telephone or online, where it's possible to buy and sell shares listed on the London Stock Exchange for a fixed fee of around £6 - £15 per trade. Some brokers also deal in companies listed on overseas stock markets, although expect dealing costs to rise to £15 or more per trade. Beware brokers who charge a percentage (rather than fixed) fee as they'll probably be more expensive, especially on larger trades.

The cheapest deals buy and sell shares on a 'nominee' basis. This means you don't receive a share certificate and may not benefit from any shareholder 'perks'. However, it's a very practical and cost effective way to trade. If you buy shares this way it's normally best to sell using the same broker you purchased the shares through. While you can usually transfer shares from one broker's nominee account to another, it can be a slow process taking several weeks.

When you buy shares you'll have to pay stamp duty at a rate of .


Buying shares in your employer

If you're an employee you may have an opportunity to buy or be given shares in your employer. This normally take the form of a save as you earn (SAYE) scheme, share incentive plan (SIP) or share options.

SAYE (Sharesave)SIPShare Options

You can save between £5 - £250 a month into a SAYE scheme for three or five years (seven years may also be available but is five years of contributions left for another two years). You receive a tax-free bonus (equivalent to a fixed rate of interest) at maturity and have the option to buy shares in your employer with it.

The price of the shares is set when you start the scheme and can be up to 20% less than your employer's share price at that time. If you take the money out before maturity the bonus becomes taxable.

SAYE schemes can be a good idea if you believe in your employer's prospects. Even if their share price falls you'll still get back your money plus some tax-free interest at maturity.


Shares jargon

Here's some of the more common shares jargon you might come across:

JargonMeaning
AiMThe Alternative Investment Market, a London based stock market where shares in small companies are traded.
BearAn investor who believes share prices will fall. Likely to sell shares in the hope of buying them back at a lower price in future.
BullAn investor who believes share prices will rise. Therefore likely to buy shares now in the hope of selling at a profit in future.
Convertibe SharePreference shares that give the option to convert into ordinary shares at a future date.
DividendThe slice of annual profits that a company pays out to its shareholders, distributed as a fixed amount per share.
Dividend CoverA ratio used to gause the likelihood a company will continue paying its current level of dividend. Equal to the profit after tax dividend by the total dividends paid out.
Ex-DividendWhen a share goes ex-dividend, dividends are only paid to whoever owned the shares before that date. The price of the shares subsequently fall by around the amount of the dividend to reflect this.
Final ResultsEnd of financial year information published by all companies listed on the stock exchange, includes details of any dividend payment.
Growth SharesShares that may not be cheap, but look worthwhile based on future growth prospects.
Interim ResultsFinancial information published after the first 6 months of the financial year by all companies listed on the stock exchange.
IPOInitial Public Offer - when shares are offered to the public prior to being traded on a stock exchange for the first time.
LSELondon Stock Exchange, the UK's main stock market, based in London.
Market CapitalisationThe value of a company based on the market value of its shares (i.e. share price x number of shares issued).
Ordinary ShareThe most common type of share. Ownership gives you a share of a company's profits via a dividend, but you'll be bottom of the pile re: getting any money back if the company goes bankrupt.
Preference ShareShares that simply pay a fixed dividend rather than participate in a company's profitability. They must receive their dividend before ordinary shareholders.
Private EquityShares in companies that are not listed on a stock market.
Rights IssueGives existing shareholders in a company the chance to buy more shares in that company.
SAYESave As You Earn, a scheme lasting three or five years that allows employees to buy shares it their employer, with security and potentially at a discount.
Scrip DividendWhen a company pays a dividend in extra shares rather than cash.
Share Incentive PlanA SIP provides a tax efficient way for employees to own shares in their employer.
Share OptionsWhen an employer gives employees the option to buy shares in the company at a fixed price in future.
StagSomeone who buys shares at an IPO in the hope they can sell at a profit as soon as trading starts.
Stock MarketA market where shares are traded. It provides a way for buyers to find sellers (and vice-versa) and determine the market price for a share.
Stop LossStockbroker will automatically sell your shares if they fall below a price you specify.
Value SharesShares that appear cheap based on their current prospects.