A share is an investment. When you purchase a company’s share, also known as a stock, you’re buying a small piece of that company, called a share.
Investors purchase shares in companies they think will go up in value. If that happens, the company’s share increases in value as well. The share could then be sold for a profit.
When you own a share in a company, you are called a shareholder because you share in the company’s profits.
Why do people buy shares?
Investors buy shares for various reasons. Here are some of them:
- Capital appreciation, which occurs when a share rises in price.
- Dividend payments come when the company distributes some of its earnings to stockholders.
- Ability to vote shares and influence the company.
What kinds of shares are there?
There are two main kinds of shares; ordinary shares and preferred shares.
Ordinary shares entitle owners to vote at shareholder meetings and receive dividends.
Preference shares usually don’t have voting rights. Still, they receive dividend payments before ordinary shareholders and have priority over common shareholders if the company goes bankrupt and its assets are liquidated.
An ordinary share represents partial ownership in a company. It is the type of share most people invest in. A common share comes with voting rights and the possibility of dividends and capital appreciation. It has a higher risk but offers higher rewards too.
Returns from Ordinary Shares
One of the ways share-ownership pays is through dividends, the portion of a company’s earnings paid to shareholders. To compute a share dividend yield, divide the annual dividend amount by the current price per share.
For example, if a share is priced at Rs 100/- and the annual dividend is Rs 5 per share, the dividend yield would be 5% (Rs 5/ Rs 100).
Many ordinary shares and preferred shares pay dividends. The amount and timing of dividend payments are at the discretion of the company’s board of directors. No law directs a company to pay a premium on its ordinary shares, even if a company is profitable. The board of directors can raise, reduce or even eliminate a company’s dividend rate; however, companies try to maintain a relatively even flow of dividends and increase the dividend when the company enjoys growth in net earnings.
The expected receipt of dividends is sometimes just enough for investing in shares, particularly if the yield on the investment exceeds the return provided by saving and fixed deposit accounts. Shares that pay out a reasonably generous dividend are known as income shares. While dividends are essential to many, most investors hope to gain an additional return in the form of capital gains.
When buying a share, an investor typically hopes that the company’s market value will rise, producing a capital gain when the shares are sold later to someone else at a higher price. Shares that are expected to grow over time are known as growth shares. Investors buy such shares in anticipation that their share price will increase over time as the company prospers.
The Demand for Ordinary Shares
Owners of ordinary shares have no guarantees but accept the risk in exchange for potentially more significant gains than other safer investments.
Ordinary shares are very volatile and are generally considered a high-risk investment class. In the case of liquidation of the business, owners of ordinary shares last in line behind creditors, bondholders, and preferred stockholders. The liability of common shareholders is limited to the face value of the shares.
Preferred shares are securities considered “hybrid” instruments with equity and fixed income characteristics. They typically carry no shareholders voting rights but usually pay a fixed dividend.
Preferred shares are so called because their holders have some priority over owners of ordinary shares regarding dividends and also in the distribution of assets if the company is liquidated or reorganized in bankruptcy.
Preferred shares, which not all companies issue, generally entitle the share owner to receive a fixed dividend before any payment could be made to the holders of ordinary shares. Owners of preferred shares carry a superior claim against assets if a company is liquidated. Some preferred shares are convertible into common shares at fixed exchange rates.
Two factors largely determine the value of the preferred shares:
- The percentage of fixed dividends.
- The price at which it is convertible into ordinary shares.
Because the dividend percentage of preferred shares usually does not change, these shares generally have many characteristics of fixed-income securities.
Typically, there are smaller price swings with preferred shares than with ordinary shares, so there is less risk. Common shares, however, provide a better way to maximize participation in a company’s potential growth.
Preferred shares do not accord ordinary shareholders voting rights unless the company is financially unable to make its dividend payments.
Conclusion: Which Type of Share Should an Investor Prefer?
Many people may have a question as to which kind of share is better. While everyone’s financial situation is different, a few broad generalizations could be made.
Preferred stock is most useful for people who don’t want to take any high risk in the market. This is especially true if they are investing in a share that pays a dividend because the dividend on preference shares amount is relatively more assured than the dividend on ordinary shares. However, the price of a preferred share will not grow as fast as that of a common share. Common share, on the other hand, is best suited for someone looking for much capital appreciation, i.e. growth. There is more risk involved, but in investments, the greater the risk, the greater the reward.