Introduction to shares

What you’ll learn:

• What the main types of equity and bond funds are.
• What the difference is between active and passive investing.
• What multi-asset and multi-manager funds are.

Buying company shares can be exciting. As a shareholder, you will have a stake in the company you’ve invested in and you have a right to vote supporting or criticising directors’ decisions. If the company performs well, you should receive an income in the form of dividend payouts. And, over time, there is the potential for further returns from the growth in the share’s value though, of course, they could fall in value. Here’s what you need to know about investing in shares.

What are shares?

Companies issue shares as a means to raise money. This may be to finance company expansion, a new development, or to move into overseas markets. When you buy shares, you effectively become a part owner of the company. The bigger the investment you make, the bigger your stake will be in the company.

What factors move share prices?

The stock market is driven by supply and demand. For any share dealing to take place, there must be investors willing to sell their shareholding (providing the supply) and buyers wanting to buy them (creating the demand).

Investor sentiment moves share prices – the market's collective view of a company. What a company does, how it behaves, how it interacts with its customers, its reputation – all of this matters to the market, and will be reflected in the share price. Profits matter, too, as does cash flow and other indicators signalling robust financial health.

If you are investing without advice from a stockbroker, you should always thoroughly research any company you are considering investing in by looking at its website and reading annual reports.

There are other factors that can move a company’s share price called corporate actions, such as mergers and acquisitions. Find out more about the common types of corporate action.

What return can I expect?

There are two ways you can earn money from shares. First, you buy the shares at a price that you hope will increase over time. This is called capital gain, growth, or return. Second, you may receive an income in the form of dividend payouts. Dividends are a distribution of the company’s profits.

Of course, past performance of any company is never a guarantee or indication of future performance. A share’s value can fall as well as rise and investors always need to be aware of the risk of losing more than the sum they invest.

What kind of investor should hold shares?

Shares won’t be the right investment for everyone.

They are not a risk-free investment, so you should only put money into shares that you can afford to lose. There’s no investor compensation fund to refund any losses if a company’s share value plummets or the company whose shares you hold goes bust. The sum used to buy shares should be money that you can afford to put away for at least five years (preferably longer).

An advantage of shares is that they can be sold quickly – which puts them in the same category as other so-called ‘liquid’ assets. But, the downside is you could sell at the worst time and end up losing money. If you’re uncomfortable accepting this level of risk, you may want to speak to an independent financial adviser before you start investing.

Risk vs reward

There are many potential advantages to be gained by investing in shares, but you should always make sure your portfolio is properly diversified. You can do this by spreading your investment capital across several different asset classes, so that you reduce the risk of too much exposure to just one. A model portfolio would be balanced across the four main asset classes – shares (also known as equities), Government and corporate bonds, property and cash. Funds, particularly those called multi-asset funds, offer a full spread of all these listed asset types. For first-time investors, as well as seasoned ones, a fund can provide a far more diversified investment than a single company’s shareholding ever can.

Jargon-busting

What does it all mean?

Price-earnings ratio (p/e) - the company’s earnings per share divided by the share price

Cash flow – the company’s earnings after tax

Dividend – distribution of the company’s profits made to shareholders

Earnings per share – the company’s net annual income divided by the number of shares on the market

Price-to-book ratio (p/b) – value of the company’s assets per share, divided by the share price

Yield – income return from the shareholding, calculated by dividing the annual dividend payment with the share price. The yield is expressed as a percentage