Shares

In essence shares are very simple. This article explains the basic concepts of what shares are about.

A share basically certifies the membership in a corporation. This means the owner of a share - the share holder - becomes a partial owner of assets of the corporation.

One of the benefits of share is that (generally) they can be sold without limitations. For larger corporations in many cases this happens so often their shares are traded on public share markets. The corporation is publicly listed.

Share Markets And Share Price

The price for each share is not determined by the value of the underlying assets. Instead the seller and the buyer need to agree on a price. For publicly listed corporations the price is determined through supply and demand.

Raising Capital

There are different reasons why you would want to set up a company based on shares - often referred to corporation as such a company becomes a legal entity on its own. One the reasons is that for certain types of businesses a large amount of capital (read "cash") is required to get started. E.g. think of oil exploration, buying or operating a 300 meter cruise ship, founding an airline, etc.

Usually single individuals or even a small group of people don't have enough assets for this. So a large group of people is required each contributing a small portion to the corporation. Some corporations have hundreds of thousands of people who contribute to its capital. These people are also called share holders as they own one or more shares in the corporation. So, the first reason to found a corporation is to make certain businesses feasible.

Raising capital is not only important when a company is started but also later to extend the business. For instance a company may want to start marketing its products and services in an additional country. This may require a substantial amount of capital. To finance this expansion it can issue and sell new shares and use the proceeds of that sale.

Reduction of Liability Risk

Shares offer an effective means to reduce certain risks. For instance if a corporation is subject to liability at most the corporations can go down the drain. For the share holder this means that his/her maximum loss is the shares, which become worthless in these cases. Effectively the liability is limited to the share itself and does not extend to the owner of that share.

There are other risk associated with shares, e.g. a decline of the share price, but this are not unique to shares and so we won't cover them here.

Shares as Currency for Acquisitions

If shares enjoy a high valuation on the share markets then it may be used as a currency for acquisitions. The corporation pays for a new business with its own shares, either newly issued or acquired previously in the share market.

Advantages for Investors

Liquidity

As a long-term investor shares offer a number of advantages. One of them is liquity, which is important if you would like to increase or decrease your investment easily and within a short time frame. You want to be able to react quickly which doesn't mean that you give up on your long-term strategy. Note that this is different to day-trading here!

Liquidity means that a large number of shares is traded each trading day. For the investor this means it is relatively easy to sell or buy shares as there will most likely be a buyer or a seller who can be matched with your order.

Dividends

A dividend is a cash payment by the company to the share holder. Sometimes a company doesn't earn enough money (or even looses money) so that they cannot pay a dividend (any more). As a long-term investor you typically try to avoid this type of companies.

In other cases a company may deliberately choose to not pay a dividend as they want to re-invest that cash into the company. This case is acceptable or might even be desirable depending on your tax situation.

As a long-term investor you want to focus on companies that are paying a dividend already and which have a sufficient potential to even increase the dividend. As of January 2008 General Electric (US) has increased its divident 33 years in a row!

So the advantage of dividend paying companies is that the dividend may increase as the earnings go up. Compare this with bonds where the interest does not increase during the lifetime of the bond.