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What are shares?

Chapter 1: Intro

Imagine you own a piece of a company. That’s what happens when you buy a share.

Shares are how companies parcel out the money that they raise to carry out their business. That money is called ‘capital’ or ‘equity’ – and shares are also referred to as ‘equities’ or ‘stocks’.

So, if a company divides its capital into 100 shares with a face value of £1 then its ‘issued capital’ is £100. However, other would-be shareholders may be prepared to pay more for those shares, let’s say £1.50 each, so then its ‘market capitalisation’ or ‘market cap’ is £150 – 100 x £1.50.

Chapter 2: Why buy shares?

Shares can be worth investing in for two reasons. Firstly, they may go up in value, as in our example. If you’re the investor, this means you’ll get a capital gain when you sell them. Secondly, companies may also pay out dividends – a proportion of their profits – to shareholders.

Two things to remember: shares may go down in value as well as up (and they could become worthless if the company goes out of business). Secondly, companies may not pay dividends at all but prefer to retain their profits. Technology companies often do this – so shareholders take the risk that the company will prosper and value of the shares will increase.

Chapter 3: How do I invest in shares?

It is technically possible to buy shares in private companies. Let’s say a friend or relative starts a business and you invest in it. You’ll receive shares but they will probably be ‘illiquid’. You will have difficulty in selling them and their terms of sale may be restricted.

The most liquid shares markets are public stock markets or exchanges like the London Stock Exchange, the New York Stock Exchange, NASDAQ, AIM, Euronext, and the Hong Kong Stock Exchange (see here for the full list). 

You can buy or sell shares on these by contacting a stockbroker, securities dealer or banks that offer share-dealing services. The easiest way to buy or sell is by means of an online trading platform supplied by these firms, linked to a bank account.

You’ll see the prices of shares are quoted with two prices: ‘bid’ and ‘offer’ or ‘ask’. The ‘ask’ is the higher of the two and the price someone will sell you the shares at. The ‘bid’ is what they will pay you for your shares when you sell them. The difference is called the ‘spread’ – and this is the profit the broker makes on shares they buy and sell.

Chapter 4: What affects share prices?

It’d be very simple if a company’s profitability were the only thing to affect its share prices. But there are actually lots of factors to consider.

For sure, a company’s current strength is important – but owning shares is really a bet on future company performance.

Then you need to think about supply and demand of the shares in market. The more shares available, the lower the price. But remember: one of the big upsides of very large companies (like BP, Shell, HSBC, Apple, etc.) is that they’re generally very liquid. There are always shares available in the market to buy and sell.

Then there are general market trends; these are reflected by indices such as the FTSE 100, S&P 500 of the Dow Jones Industrial Average. In other words, the whole market can go up or down.

From company announcements, political events, news stories, interest rates changes and broker reports to whether large investors (such as pension funds and insurance companies) are buying or selling, and sometimes just a ‘gut-feeling’ in the market – there are a lot of factors that can affect the price of shares at any time.

Chapter 5: The good and the bad

Shares can be a great way to get share dividends and a capital gain on your investment. Just leaving your money in a savings account can’t offer you this double whammy of a reward. That’s the good news.

The downside is that you can lose your capital if the price of your shares falls, and the company may reduce or cancel its dividend. But these are always the risks of investing in shares.

Now you know…

1. Shares are pieces of a company’s capital.
2. If you invest in them you stand to gain an increase in your capital and a dividend.
3. But you could none of these. Your risk is limited to your investment but you could lose it all.
4. Many things affect the price of shares. Even the so-called experts and full-time market analysts frequently get it wrong!
5. But… if you are shrewd, lucky, attentive and are prepared to take on the risks of investing in shares, you may make money.

Test yourself

Assume the spread on an instrument is 10 cents. What is the ask price, if the bid price is $23.35?

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