Shares are worth of a unit of the total value of a business
At a basic level, a share is the worth of a unit of the total value of a business. This means that if the total value of a business is divided into small equal pieces or units, one-piece or unit represents a share.
The founders determine how many pieces the value of a business is divided into. It could be 100 or 1,000 or one million.
It really does not matter how many pieces it is divided into because the value of the whole business remains the same irrespective of the number of pieces.
Conceptually, if you assume a cake represents a company, then you may think of a share as a piece of the cake. No matter how many pieces you cut the cake into, the size remains the same when you put the pieces back together.
The value of the business is the money worth of all its assets, be it cash in the bank, money it is owed, physical assets like buildings, vehicles, furniture, land, computers, brooms, carpets and so on; everything that is under its name, no matter how tiny.
Seen from a different perspective, shares represent ownership of a company. When an individual buys shares in a company, they assume part ownership.
Thus, a share can also be considered to be a unit of ownership of a company. The word stocks are interchangeably used with shares.
Those who own shares of a company are called shareholders. Collectively, shareholders decide how the company is run and who runs it.
Whenever a business is incorporated to become a limited liability company, it has to establish its value and accordingly split that value into the number of shares agreed by the original owners.
At a future date, the company may decide to sell some of it shares at a premium to outsiders in order to raise more capital to finance growth.
If this is done through a stock exchange, the company ceases to be private and becomes a public company. This process is popularly referred to as an IPO, an acronym for initial public offer.
People interested in owning a piece of this company many now buy shares from second parties at the stock exchange. That explains why the stock market is called a secondary market.
Shares are useful because they are a financial instrument or security. This means that one can invest through them over a period of time and gain profit. Depending on how the business they represent is run, shares grow in value.
Because they are associated with high price appreciation over relatively short periods of time, they are popular with investors and traders all over the world. However, it must be remembered that just like any other financial instrument, they are prone to risk. Luckily, there are strategies to minimise that risk.
The benefits of shares come mainly in two ways: through dividends and capital gain.
Dividends are the money hived off the profits made by the company and given to shareholders, usually twice a year.
If a company does not make profits, shareholders cannot expect dividends. It is also not a must that a dividend is given, even when a company has made good profits.
The board and management may decide to reinvest all the profits to finance new projects instead of borrowing from external sources.
Dividends are distributed in proportion to the number of shares a person owns.
The more the shares, the more the dividends. In most cases, consistent dividends are associated with stable and mature companies.
Apart from dividends, shareholders benefit through capital gains. As we said earlier, the value of a company grows with time and since its value has a correlation with the price of shares in the market, it is possible to buy shares at a low price and sell them at a higher price. The difference between the buying and selling price is the capital gain.
The fact that there is no telling how high capital gains can go or how quickly they can be achieved endears investors and traders to invest in shares.
There are numerous cases where stocks have doubled, tripled or quadrupled over unbelievably short periods of time, making investors very rich.
However, it should be noted that shares carry risk too. Like other investment options, shares can also bring losses when one does not have a strategy with clear buying and selling rules or allows emotions to influence his/her investment decisions.
The writer is the author of The Ultimate Framework for Success in SharesEmail: [email protected]