A share is a stake in a company
When you buy a share you, quite literally, buy a stake in a business. No matter how huge the company, owning one share makes you one of the owners of that company.
Shares are often called ‘equity’ as they represent the value of a company divided into equal parts. In theory, if a company was wound up and all its interests and property were sold off then the shareholders would all get a share of the outcome, based on how many shares they hold.
Shareholders are also entitled to a share of the company profits, which is usually paid out through a dividend. This is one of the most important benefits of owning a share – in the long term, dividend payments could make a big difference to your return.
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Share prices are set by buyers and sellers
That said, share price movements are also an important part of investing. Buying a share when the price is low and selling when the price is high is one of the main ways that investors hope to make money. For this reason, it is very important to understand what a share price represents.
The share price you see quoted is the last price that an investor paid for a share. This is a very important point: a share price is not like a price in a shop. It’s simply the value that one investor puts on a company’s share at any one time. You can sell a share for as little as you want or as much as anyone will pay.
Share prices are driven by basic supply and demand. If demand for a particular stock outweighs supply, its price will go up; if investors fall out of love with a stock, then the opposite will happen.
Demand for a share can rise when investors think that a company’s fortunes are improving. Some reasons for this could include:
- The company has launched a new product
- The company might be subject to a takeover bid
- Changes in the economic backdrop favour its product or service
Similarly, bad news can see demand for shares fall, for example if a company issues a profit warning or suffers an unsuccessful product launch.
Investing in shares is a long-term project
Prices can also be driven by sentiment, particularly in the short term. Experienced investors sometimes use the term ‘animal spirits’ to describe this. This can cause share prices to rise and fall sharply in short periods – the ‘animal spirits’ take over and investors sometimes overreact to good or bad news.
This is why it is important to see investing as a long-term commitment. Over the long term, the quality of a company’s business should be the main contributor to share price movements. Short-term unpredictably can be unnerving, but successful investors hold their nerve if they believe the long-term rationale for an investment holds.
It’s important to be aware of the risks
If you are thinking about investing in shares, then it’s important to understand some of the risks that come with it.
Share prices can go up and down unpredictably
Investors call this ‘volatility’. Share prices are more volatile than other types of investment, such as bonds and cash. At any one time it can be hard to predict how much your investments might be worth in the future.
There is no guarantee that a company will be successful
While many companies are successful, many fail even if they look good on paper and investors lose out. This can also afflict specific sectors – for example, where all investors suddenly lose faith in oil companies or banks – or across the entire share market. Sometimes this can be a matter of holding your nerve and waiting until markets recover. At other times investors need to accept the loss and move on before they lose even more.
You can’t completely avoid these types of risk, but many investors spread their money across lots of shares in a diversified portfolio, only risking a small amount of their savings on any single company.
One of the more efficient ways of doing this is by investing in an equity fund. When you invest in a fund you pool your money with other investors and a professional fund manager then invests this collective sum into a wide variety of shares.
Helpful information to help you understand your investments.