After having several conversations it is clear that the business of share trading and its intricacies still create a dark cloud to many. A rather unnecessary element of sophistication at that.
It is thus only fair to (in true debunqed.com fashion) take a step back, delve in and break it down by discussing not just the way to trade, but the whole point of it.
Trading may seem like something only smart people engage in. This is, however, not the case.
What are shares?
The first thing to understand is that shares (referred to in the US as stocks) entitle the holder to have part ownership in a company.
You are basically co-owning with other stakeholders of the company with the hopes that the people who run it will increase the monetary value of your shareholding by making the company a success.
Now your share/ownership will determine what level of control (decision-making powers) you have when it comes to the company’s operations.
Naturally, owning just 1, 10 or even 1000 shares of Amazon (which cost around a hefty $1400 each today), still does not entitle you to have a say in how it is run.
The majority shareholder – which would probably be the company owner (chairman/founder) or its board of directors, depending on how the company is structured, will still have the overall say.
To gain a majority shareholding and therefore full control of a company, the minimum number of shares one would need would be 51% of the total issued. Good luck obtaining that many!
Rationale for issuing shares
But let’s take a further step back and unravel why shares are issued in the first place. A company has a value. This makes it a constant target for investors in a capitalistic market. Wealthy individuals carefully monitor its value to brace for a potential takeover or for just a piece of the pie.
To get listed on a stock exchange a company will decide how much of its equity to publicly issue as shares. You can even issue share to raise more capital to help grow your business.
This form of equity will be backed against its total assets (and its debts) on its balance sheet. So hypothetically, a company with 100 Euros worth of assets and liabilities has 100 Euros worth of (owners) equity.
This basically enables you to determine its net worth at a given point in time.
The easiest way to remember this is through this basic accountant’s formula:
Total Owners Equity (OE) = Assets (A) + liabilities (L).
The shares are accounted for in the OE and are issued in denominations based on various factors. This helps to provide you with an indication of the relative strength (or weakness), or potential growth rate of the company.
What do they tell us?
The (snapshot) total value of the company is thus determined by its share price multiplied by total number issued. This is referred to as its market capitalization. There are several other measures and tools to evaluate the general health of a company.
Shares for large companies are naturally offered in millions and via an initial public offering (IPO) from as little as one cent or more (depending on its valuation upon listing on the market) and rise to what was quoted for Amazon earlier.
Where to get them
The open market of local bourse is where shares can be bought and sold at specific times depending on side of the world it is located – just like in a traditional marketplace.
Obtaining shares may come with an additional cost (brokerage fees, commission, interest payments in cases of leverage buying etc.) depending on the terms and conditions of the market but more specifically, on the company or broker offering access to the shares.
A good company share will also offer you a return an annual dividend. This is basically a share of the company’s profits over and above its share price.
So, it is a good idea to include dividend-yielding shares in your trading portfolio if you can afford them.
Once you purchase your stake in the company, you will naturally, even if you don’t have a controlling say in how the company is operated, take a keen interest in the company’s activities.
Everything it does whether internal operations or outside for that matter, will have an impact on its valuation.
Naturally, investors follow the age-long rule of common sense: buy when the price is low. If you missed the IPO and the price dips, you can always get in at a good (low) price. The stock market runs like a rollercoaster – you just need the right time to hop on!
“Unless a company goes belly-up, a share-stock price that is going down is actually going up – in the long run.”
Obviously, the price (trend) is not always upwardly and one must be prepared to weather such storms. This is possible by not continuously focusing on the shares once you have done your thorough due-diligence (something that applies to all other assets including property) and purchased for the long haul.
Playing blissful ignorance is the best advice you will get as you can become emotionally attached to the performance of the shares and that can affect your mood.
There are also a lot of trading tools to help prevent a total meltdown if the company folds-up due to external factors such as fraudulent scandals or government intervention. Keep tags now and then – this is important.
The recent events and scandal faced by Facebook saw it lose a significant amount (billions of dollars within weeks) in it the value of its share price.
Short-selling of shares/stocks
There are also ways to “have ones’ bread buttered both ways” and this is where the concept of short-selling comes in.
So, while we all inclined to bet on a company’s stock to go up – there are groups of investors who bet the other way. The have the hopes (based on indicators such as valuation) that the price will rather drop.
This seemingly dubious form of trading is perfectly legit but comes, naturally, with an even higher level of risk. If the price increases in favour of all ‘normal’ long-term investors – the short starts to lose money. You may even have to fork out more to cover the amount borrowed to make the short-sell in the first place.
Short-selling not for the inexperienced and ill-informed!
So, you “buy” or rather borrow (with leverage) the future value of the share/stock price usually at its apparent peak and hope that it will drop for you to profit from the bet by as much as it continues to drop.
Earlier in the year, one such investor dubbed “50 Cent” bagged 200-million-dollars in a major shorting stint.
Shorting a stock is a complex, risky but highly lucrative method of balancing out a portfolio. A seasoned trader will, therefore, have several positions including some “buy” and “sell” positions on their shares for long and short terms.
You should have various mechanisms (take profits and stop losses) set in place to execute their trades based on those positions.
Naturally one wouldn’t just short a stock if you didn’t know something about what factors were to lead to a sharp/large drop in the share price.
But getting this right is often an exercise that straddles a fine line between being well-informed and intuitive and blatant insider trading.
So, in summary, shareholding generally occurs when you acquire a stake in a business. You can do this via ownership of its intellectual capital, founding rights, or though the status as a funder or seed investor to help start the business.
So why do companies issue out shares to the public again you might still ask?