Australian Share Basics
What are shares?
A share is a part ownership in a company. The ownership share can be for either a private or public company. The share may entitle you to a slice of the company’s profits (if there are any) and voting rights in some company decisions.
Publicly listed companies are those companies listed on a stock exchange (like the ASX). These companies have greater liquidity as there are people looking to buy your investment should you wish to sell.
Shares can be purchased directly on the sharemarket or via units in a managed fund.
The purpose of investing in shares is to derive a return on that investment over time. This return can come in two forms; as income in the form of dividends, and as capital growth in the form of an appreciation in the underlying value of the share.
How is a shares price derived?
Share prices as quoted daily are a direct result of market forces. What this means is that share prices change because of supply and demand. This simply means that if more people want to buy a share than those who want to sell it (demand is greater than supply), the price moves up. Conversely, if supply outweighs demand, the price would fall.
This theory of supply and demand is easy to understand. What is more difficult to comprehend is what makes people want to buy or sell a particular stock.
The price movement of a particular share indicates what investors feel a company is worth. It is important to differentiate between a company’s value and a share price. The value of a company is its market capitalization or the share price multiplied by the number of shares. However to further complicate matters; the price of a stock doesn’t only reflect a company’s current value, but also the growth that investors expect in the future.
The most important factor that affects the value of a company is the company’s earnings. A company’s earnings are the profits a company makes, and profits are essentially the reason for the existence of the company in the first place. These profits are distributed to shareholders in the form of dividends which form a source of income for the investor. Analysts base their future value of a company on their earnings projections. Investors use these projections to form the basis of their investment in a company. Hence if a particular company is expected to have strong earnings growth into the future, the shares price will appreciate as investors buy the stock in the expectation of receiving a slice of the future earnings in the form of a dividend.
There are many other factors which affect a shares price on any one day. Short term price fluctuations are usually the result of information which becomes available to the market. For example a company may release information to the market regarding a particular venture. If this information has not been anticipated by the market it will have an effect on the price of the share, being either a drop or a rise in the price of the share. These price fluctuations can be significant depending on the importance of the announcement.
In a later entry we will explore some methods you can use to value a company and then compare your value with that of the market. This can be a powerful tool in uncovering stocks which may have significant changes in their values in the future.
What is a stock exchange?
A stock exchange is a place which provides trading facilities for stock brokers and traders to trade shares and other securities. It is not necessarily a physical location, but might be online trading facilities like in the case of the Australian Securities Exchange (ASX).
For a share to be traded on a stock exchange, the company must be ‘listed’ with the exchange. To list on a stock exchange the company must comply with the listing requirements of the exchange. These listing requirements include initial listing requirements such as the lodging of a prospectus, and ongoing listing requirements like if and when information must be released to the market.
More to come…