This ‘investing in shares online’ guide starts with the basics and expands to explain the various supply and demand drivers which impact share prices and the best online execution share dealing accounts to use for your investments.
WHAT ARE SHARE INVESTMENTS?
When you purchase a share, you are acquiring a stake in a business. Company shares can either be private (in which case shares are traded privately and prices are negotiable) or public (in which case the shares are traded on a stock market with prices fluctuating based on supply and demand).
Shares are one of two ways in which a company can raise money, the other being via a debt raise. For example, lets consider a restaurant business which wants to expand existing operations in the South West and London to open up several new outlets in the North of England. In order to do this, the business requires capital to kit out the various new leased premises. Supposing the business has insufficient free cash flow from operations to finance the expenditure, it has two options to raise the cash required: 1) it can either take on debt or, 2) raise cash from investors in exchange for a share of the business.
When a business takes on debt, it must make interest payments on the borrowed capital. If this option isn’t attractive (e.g. where the interest rates offered are deemed to be too high), the company can sell existing shares or issue new shares. For example, if the company has a market capitalisation of £3.0 million (total value of existing shares) and requires £0.3 million, it could sell 10% of existing shares to raise the required capital. In this scenario, the existing shareholders would retain 90% of the company’s shares.
Owners of ordinary shares do not receive interest payments, but rather they have an entitlement to a share in the profits of the company.
HOW CAN YOU MAKE MONEY WITH SHARES?
Investors in shares can profit via two means:
RISING SHARE PRICES
Continuing with the above example, if the business is successful with its new restaurants in the North, the business may have grown profitability which in turn has increased the value of the business. Whereas previously it was worth £3.0 million, one year later the market capitalisation has grown to £4.0 million. As such, the 10% of share capital acquired by the new investors is now worth £0.4 million, a £0.1 million (33.3%) increase.
Dividend payments are cash payments made by the business to its shareholders. Many businesses pay dividends as company investors often seek a regular return on their funds. However, dividends are not mandatory as cash profits could be retained by the business to drive further growth.
Dividends can be paid at any point during the year, but most listed companies stick to a published timetable with dividends either being paid quarterly, half-yearly or annually.
When comparing share prices between companies, investors often look at dividend yield (calculated by dividing the current share price by the last full year dividend). However, this measure should not be looked at in isolation. Investors need to consider the forward outlook to determine whether the business will generate sufficient cash profits to maintain dividend payments in the future.
When a share is traded ex-dividend, it means that the share price is trading without the value of the cash due to be paid out as a dividend to the shareholders at the point of the ex-dividend declaration. When this happens, the share price typically drops because there is a committed cash outflow which reduces the value of the businesses assets.
Because many companies pay dividends, you cannot simply look at the buy/sell price of shares to determine shareholder return. Dividend payments must be considered, by calculating ‘Total Shareholder Return’.
ARE THERE DIFFERENT TYPES OF SHARES?
Yes, there are three different types of shares: ordinary, preference and convertible.
Ordinary shares – The most common share type. Ownership of ordinary shares gives investors the right to receive dividends (after preference shareholders are paid) and the right to vote on company issues. As an ordinary shareholder, you own a share of the company’s assets and will benefit from rising profitability. However, in the event the company becomes insolvent, ordinary shareholders rank behind debt holders when payments are made as a result of the administration process.
Preference shares – Preference shares pay their holders a fixed dividend payment. This payment must be made before dividends are paid to ordinary shareholders. There are two types of preference share – cumulative and non-cumulative. The sole difference is that if a payment is missed (e.g. due to the company being in financial trouble), cumulative preference share holders retain the right of payment in the future whereas non-cumulative preference shareholders lose the right to that payment.
Convertible shares – Convertible shares are preference shares which can be converted into ordinary shares at a fixed conversion ratio. These shares benefit from the fixed payment structure of a preference share but provide higher potential for capital growth in the event that the ordinary share price rises in the future. Once a convertible shareholder opts to convert their shares, they forfeit their rights as a preferred shareholder (and thus will no longer receive fixed dividend payments) and become an ordinary shareholder.
WHAT FACTORS CAN IMPACT SHARE PRICES?
The price of shares are ultimately determined by supply and demand. However, there are a number of key drivers which can impact that supply/demand.
SUPPLY FACTORS IMPACTING SHARE PRICE:
Share issue – Where a company issues new shares to the public, this increases the number of shares in circulation. Often, the company will need to offer shares at a discount to the open market value to entice new investors to participate in the offering. This typically reduces the price of the listed shares as buyers/sellers will be aware of the secondary offering.
Share buyback schemes – Where a company buys back some of its listed shares to reduce supply. Once shares are repurchased, they are either cancelled or held back for potential redistribution in future.
Sellers – Sellers may be motivated to sell for a number of reasons (e.g. to crystallise a profit, fund another purchase, or because they no longer believe in the prospects of the business and believe share prices will fall). When a seller lists their shares for sale, it increases the supply of available shares. If demand doesn’t match the increased supply, the price will reduce so that those who wish to exit their investment can liquidate their shares.
DEMAND FACTORS IMPACTING SHARE PRICE:
Company news – Any news about a company, expected or unexpected, can cause fluctuations in the share price. For example, a company may file a quarterly update which announces profits in excess or below budget or a new breakthrough development (e.g. medical companies developing drugs).
Market sentiment – The general feeling in the market about a particular share or industry. For example, investors may be feeling generally positive about the potential growth in new product development at the Big Tobacco companies, or they may be more focused on the reductions in smoking rates in certain Western markets.
Economic factors – Macroeconomic factors can have a big impact on share prices. For example, changes in inflation or central bank interest rates. An unusual recent example would be the Coronavirus outbreak which has led to entire countries being locked down and significantly impacting both supply chains and consumer demand.
Industry trends – Demand for shares in a particular sector may rise if one firm posts strong results. This is because companies operating in the same industry are often exposed to the same pressures. For example, if EasyJet posts a quarterly update boasting strong passenger numbers and increased profits as a result of falling oil prices and increased consumer confidence, RyanAir shares may rise.