How do shares work?

You may have heard about an Initial Public Offering (IPO) and wondered what the fuss was all about. Well, companies generate capital for investments by inviting the public to become part owners. Companies start this process by listing on the stock exchange and calling on the public to buy shares through the IPO. After that, the company becomes public, and investors can obtain the same stocks from traders at the stock exchange.

Types of shares

Stocks come in the two forms of common and preferred stocks. As an ordinary investor, you will be able to buy common shares on the stock market. Common shareholders have voting rights that they can exercise during Annual General Meetings (AGMs) to influence important decisions of the company. Some shareholders may have more influence on the company’s decisions than others depending on the voting system adopted by a particular company.

Share valuation

The price of a share fluctuates depending on investor sentiment about its intrinsic value. There are several metrics that stockbrokers use to evaluate a stock. The most common is earnings per share, implying that traders rate it on the potential to deliver high dividends. However, the valuation may be subject to market forces of demand and supply, meaning that the price is indicative of investor appetite for the stock.

When you buy a share, you become a shareholder of the company. Your stake in the company is equivalent to the number of shares you hold relative to all the outstanding shares of the company. In simple terms, your stake in the company is equal to the percentage of shares you own. If you buy 50,000 shares of a company with 500,000 outstanding shares, then you own 10% of the company.

Why you should buy shares

Shares are a compelling alternative to saving money in banks as they have a higher income potential than savings. When the value of a stock rises higher than the price you paid for it, you can make a profit by selling it. On the other hand, most successful companies issue a dividend to stockholders annually, so you get income from your stocks every year. Thus, a shrewd stock investment is a form of saving and a source of income.

The bottom line

Shares are a great way of improving personal finances and creating wealth, but require some level of risk tolerance. If you are contemplating investing in stocks, you should read and consult extensively for more insights.

Written by Judith Spencer

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