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: