Introduction to Stocks
By: Dominic Holden and Charlie McMillan Summons
In UNIT’s first piece in the Intro to Investing series, “What Is Investing”, Research Analysts Gary Palar and Eric Capruciu discussed how investing can be used to achieve your financial goals. If you haven’t read it yet, we suggest checking it out first here.
Introduction to Stocks
“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”
– Robert G. Allen
While we may not all want to be millionaires, shares can deliver greater returns than your savings account. In the 30 years preceding December 31 2019, Australian shares have achieved a 9.22% yearly compounded return, exceeding the return you would receive from a savings account or hoarding cash under your mattress. This piece covers what a share is, how to buy/sell them, and how investing in shares can help you achieve your financial goals.
What is a Stock?
‘Shares’, ‘stock’, ‘equity’ are all synonyms for the same thing: an ownership stake in a business. In essence, buying stock in a company means you own a portion of that company, and therefore the right to a proportion of its assets and the money it earns. In fact, owning shares allows you to impact how a company is run, such as through voting at a general meeting.
When you hear about how Apple is a ‘trillion dollar company’, you are hearing about Apple’s market capitalisation (‘market cap’). This is what the market thinks the company is worth, at the minute. You find it by multiplying the number of shares outstanding by the share price.
For Apple: there are 4.83 billion shares outstanding x the 258.44 share price = $1.13 trillion market cap.
A company with shares trading at $40 is not more expensive or valuable than a company trading at $2. It all depends how many shares are outstanding. Indeed, Company B has a higher market cap than Company A in the example below:
|Shares Outstanding||Share Price||Market Cap|
Common vs preferred shares
Delving deeper, stocks traded on the Australian Securities Exchange (‘ASX’) are usually ‘common’ or ‘ordinary’ shares. This in contrast to ‘preferred’ shares.
Holders of preferred shares can have greater voting rights than common stockholders, and have priority of the assets of a company when it is wound up. We suggest more research into this if you’re interested.
Returns from Stocks
Source: Vanguard via Canstar
Investing in Australian shares has delivered an average compounded growth of 9.22% over the past 30 years, turning your $10,000 investment into a very attractive $141,110. This far exceeds the returns you’d receive from doing nothing. A savings account with an interest rate of 3% would turn this into just $24,273.
So with this increased reward, why would anyone not buy shares? As discussed last time, greater return implies taking greater risk. When a company is wound up, for example in bankruptcy, shareholders have a lower priority over their company’s assets and most of the time receive nothing.
Taking a look at the above graph, investing in Australian shares in 2007 just before the Global Financial Crisis would have caused you to lose money in the short term. But if you’re willing to do proper due diligence on which stocks to invest in and to bear the associated risk, stocks had a higher return in the long term and can help you achieve your financial goals.
How are Stocks Traded?
Public companies have shares that are “floated” on public exchanges, through various processes which allow anyone in the public to buy these shares. Australian companies tend to be listed on the Australian Stock Exchange (‘ASX’). This exchange allows investors to buy and sell shares electronically.
Say you want to buy 100 shares of Lovisa (LOV.AX) at $3.31 per share. You place a “buy order” through a trading platform or broker, such as CommSec, who will charge you a small fee. When your buy order is matched with a sell order, there is someone who owns Lovisa shares and is willing to sell you them at the same price, for $3.31 each. A trade occurs. You now own the shares, and the seller receives cash in return.
How Stocks Can Earn You Money
There two ways a person can earn money through holding shares: capital gains and dividends.
Capital gains are increases in the share price. If you bought 200 shares of XYZ company for $5 each, then sometime later the shares are trading at $10 each, you should be very happy. The 200 shares you bought for $1000 total is now worth $2000. This gain is ‘on paper’ only. You don’t have any cash in hand. It is not until you sell your 200 shares that you have the $2000.
Dividends are payments made by the company to shareholders from the money the company has earned. These are most often paid every 3 months (quarterly) or every 6 months (semiannually). For example, if XYZ company decides to pay an annual dividend of $0.36 per share, then over the course of the year you will receive $72 in total, $0.36 for each of the 200 shares you own. This may also be a payment of $0.18 per share, paid semiannually.
Some companies retain the money they earn and seek to grow their business using those funds and so don’t pay a dividend. Some companies pay out most of the money they earn as dividends and so their share price doesn’t tend to rise too much. Some companies will accrue gains to their shareholders through a mixture of both methods. When deciding to invest your money, the payout policy (proportion of money earned, paid out as a dividend) of the company in question is worth considering, particularly when you consider the different tax implications between countries.
In Australia, it is worth noting there is a special tax system called ‘dividend imputation’. In a sentence, it means the dividends you receive from your company is taxed only at your personal tax rate (and not taxed at both the company and your personal tax rate).
Stocks are an important tool in investing and historically have given strong returns. However, they carry an associated risk that must be considered by each individual investor. To find out how investors counterbalance the riskiness of stocks, keep an eye out for the next part in this series which is coming soon: ‘Introduction to Bonds’.
Sources: Canstar, ASX
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Other Related UNIT Articles:
Take a look at other articles in our series:
- ‘What is Investing’
- ‘Introduction to Bonds’
- ‘Introduction to Property’
- ‘How to Invest’
- ‘Introduction to Portfolio Allocation’
Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. The advice given is general in nature and does not consider an individual’s personal financial circumstance. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a finance professional before making investment decisions based off of this article.