Share Trading Basics Introduction:
Owning shares is one of the greatest tools to wealth creation you can find. Shares, apart from owning fixed property, should form the cornerstone of any investment portfolio. You do however need a firm understanding of the stock market basics before dipping your toes (and your money) into the sea of opportunity which is the stock market.
It is like having a business but not having to show up at work.
The interest of the average Joe has grown exponentially in the last couple of years. This can be attributed to the flow (mostly freely accessible ) of information on economic affairs and stock specific news. What was once a toy of the wealthy has now turned into the vehicle of choice for wealth creation. Technological advances has put the opportunity of trading the stock markets at your fingertips wherever you might be.
Most people don’t understand share trading despite the popularity thereof. You invariably hear the talk about shares at a braai or function. “Pete made a killing buying ABC company shares and he says that XYZ could be the next big thing. Watch out for these tips as your get-rich-quickly attitude will land you in the gutter. Shares can create massive amounts of wealth but not without risk. If you don’t understand the risks – don’t part with your money.
This tutorial should provide you with a foundation of understanding the stock market better.
What are shares?
A share is simply what it’s name suggests – you share in the ownership of a company.
It represents a claim on the company’s assets and earnings. It is sometimes called stock, equity or shares but they all mean the same thing.
Holding a company’s shares means that you are one of the many owners (shareholders) of a company and have claim to everything it owns.
This claim is usually very small but you are entitled to your portion and hold your voting rights. Shares were held in certificate form but electronically held shares have become the norm. All South African shares are held by a CSDP (Central Securities Deposit Participant) in electronic format.
This makes it far easier to trade the shares at the click of a mouse button. Share certificates had to be taken to the broker and then to the transfer secretaries which made it and arduous task. Being a shareholder does not give you title to the day-to-day running of the business. Your extent to which you have a say in the company is limited to one vote per share at annual meetings where you vote for the board of directors.
Being a shareholder of South African Breweries does not entitle you to walking into their plant in Rosslyn and helping yourself to a couple of beers or calling the Chief Executive Officer to share your ideas on how they should run the company.
Large institutional shareholders have the biggest say in the appointment of management and they have to increase the value of the company for shareholders. Profits are shared in the form of dividends. Your claim on the assets is only relevant should the company go bankrupt.
An important feature of owning shares is your limited liability should the company not be able to pay it’s debt. No matter what happens, the maximum value you can lose is the value of your investment in that company. Your personal assets are never under threat should the company go bankrupt.
An important feature of owning shares is your limited liability should the company not be able to pay it’s debt. No matter what happens, the maximum value you can lose is the value of your investment in that company. Your personal assets are never under threat should the company go bankrupt. Company Funding.
Debt vs. Equity. Companies raise capital by debt financing (loan from the bank or issuing a bond) or equity financing ( selling part by issuing shares. Issuing stock is advantageous as the company does not have to pay back the money or make interest payments along the way.
The first issue of stock by a private company is called the initial public offering (IPO). When you buy a debt investment such as a bond , you are guaranteed a return of your capital along 13 with interest payments. By buying an equity investment you assume the risk of the company not being successful. If the company goes bang you only get paid after the banks and the bond holders have been paid. Shareholders earn a lot if the company is successful but stand to lose their entire investment should the company fail. There are no guarantees when it comes to individual stocks.
Some companies pay dividends , but others may not. There is no obligation to pay dividends. You make money by the appreciation of the stock price. Although risk might sound negative , there is a bright side. Taking on risk demands higher returns. That is why shares outperform bonds or bank savings.
Types of shares There are two types of shares:
Common Stock and Preferred Stock
Common stock When people talk about shares they usually refer to this type. Common shares represent ownership in a company and a claim (dividends) on a portion of the profits. Investors get one vote per share to elect board members who oversee the major decisions made by management. Common shares hold the biggest risk as the holders of this asset class will not receive money until the creditors, bondholders and preferred shareholders are paid.
Preferred shares Investors in preferred shares are normally guaranteed a fixed dividend but without the same voting rights of common shares. These shares are also callable and this means the company can buy back these shares at any time and for any reason (mostly at a premium).
What makes Share prices change?
Share prices change everyday compliments of market forces of supply and demand. Participants have different perceptions of a company’s potential earnings and are therefor prepared to pay different prices for a share. If more people want to buy a share(demand) than sell it (supply), then the price moves up. Understanding supply and demand is easy. What makes trading stock difficult is understanding what makes people like a certain share and dislike another. Every investor has his own ideas and strategies. Some are just outright punters.
The price of a share is determined by what investors perceive it to be worth. The value of a company is it’s market capitalization which is simply calculated by share price multiplied by the amount of stock in free float. Matters are complicated by the price of a share which reflects the growth that investors expect in the future.
The most important factor in valuating a company is it’s earnings. Earnings are the profit a company makes. Without profit it can’t survive. Companies are required to report their earnings and the market watches these reports to determine future value. If the earnings surprise share prices jump and conversely when they disappoint the stock prices fall.
Sentiment is a very important driver of price as was evident in the dotcom bubble. Tech companies saw their valuations shoot through the roof despite them not making a cent yet. These valuations did not hold and their values shrunk to a fraction of the highest prices they achieved. There are numerous variables that influence price and investors are developing more and more to determine valuations.
You might have heard of like price/ earnings ratio, while others have obscure names like Chaikin oscillator or moving average convergence divergence. So why do prices change? Nobody really knows but we know for certain that they are volatile and that creates opportunity.
At the most fundamental level , supply and demand in the market determines share price.
– price times number of shares in free float is the value of the company. Comparing just the price is meaningless.
– earnings affects investor’s valuation but other indicators are also used to predict the price.
– there are many theories that explain share price movement. There is however no one theory that can explain everything.
How do you buy and sell shares. You luckily don’t have to go into a trading pit and yell your order. There are two main ways to purchase shares.
Using a broker There are two types of brokers :
full-service who supposedly offer expert advise and charge higher fees and discount brokers who execute without any add-ons.
With the advent of the internet trading platform most brokerage houses have changed to the latter. Anyone can now afford to invest in the market.
DRIPs Dividend reinvestment plans allow investors to purchase stock directly from the company by reinvesting their dividends.
ABOUT JERRY MONONELA
Jerry Mononela (born 19 April 1957) is a South African Millionaire, chairman, managing director, philanthropist and largest shareholder of ALFA TRUCK LLC, a reputed global 500 and South Africa’s most valuable company by market value.