Understanding Capital and Shares

Sources of Company Capital

In order to start or expand a company, capital is required. Companies obtain this capital from various sources:

  • Owner's Funds: The owners use their own money.
  • Borrowing: Money is borrowed from banks or other individuals.
  • Issuing Shares: The company issues and sells shares to investors.

The Advantage of Raising Capital Through Shares

When a company raises capital by issuing shares, it offers a key advantage:

  • The company does not have to pay back the money to the investors.
  • The company does not have to pay interest to the investors.

Instead, shareholders are entitled to a share of the company's profits.

Investing in Shares (Stock or Equity)

What is a Share?

A share, also known as stock or equity, is the smallest unit of ownership in a company. If you own a share of a company's stock, you are a part owner of that company.

Why Invest in Shares?

People invest in shares with the primary objective of generating wealth. Studies have shown that equities are one of the best long-term investments, often offering better returns than:

  • Government bonds
  • Corporate bonds
  • Property
  • Many other investment types

Returns and Rights for Shareholders

As a shareholder, you benefit from two primary forms of profit and certain ownership rights:

  • Dividends (Share of Profits): You receive a share of the profits the company makes.
  • Capital Gain: If the company is profitable, the price of its shares will rise, allowing you to make a profit when you sell the shares.
  • Voting Rights: You have the right to vote on who runs the company and other important matters (e.g., selling the company).

The Stock Market and Trading

The Stock Exchange

The stock market or stock exchange is the venue where shares are traded (bought and sold). Shares of listed companies (such as Apple and IBM) are traded on exchanges like the New York Stock Exchange.

While exchanges historically were physical locations where dealers met in person, modern markets are transitioning to online trading. Although most stocks are traded through an exchange, trading can also occur off-exchange or over-the-counter (often via CFDs).

Stock Market Indices

Stock market indices summarize the performance of major groups of stocks. They are calculated by finding an average price from the prices of the stocks within the group. Indices serve two main purposes:

  1. They represent the general performance of the market.
  2. They can be traded as a whole, instead of buying each individual share in the group.

Examples of indices include:

  • Dow Jones 30: Calculated using the closing prices of 30 of the biggest US companies.
  • UK 100: An average of 100 shares in the UK exchange.
  • Nikkei 225: Based on 225 shares in Japan.

Market Conditions

The stock market reflects a constant battle between buyers and sellers and mirrors positive or negative price movements. Share price movement is tied to profitability:

  • If a company is profitable and expected to make future profits, its share price will rise.
  • If a company is not profitable and is not expected to make future profits, its share price will drop.

Market Terminology

  • Bull Market: A market where the majority of shares or indices are experiencing a rise in prices.
  • Bear Market: A market where the majority of shares or indices are experiencing a fall in prices.

Detailed Summary

Companies require capital for operations and expansion, which they obtain primarily through owner's funds, borrowing, or issuing shares. Issuing shares is advantageous because the company does not incur debt or interest payments; instead, shareholders are entitled to a portion of the profits. A share represents the smallest unit of company ownership, and investing in equity is considered a strong long-term strategy for wealth generation, often outperforming bonds and property. Shareholders earn returns through dividends and capital gains (selling appreciated shares), and they receive voting rights. Shares are traded on the Stock Exchange, and Stock Market Indices (like the Dow Jones 30 or Nikkei 225) summarize overall market performance. Market conditions are classified as a Bull Market when prices are rising or a Bear Market when prices are falling, movements which generally reflect a company's profitability and future prospects.

Key Takeaways

  • Company capital is sourced from owner's funds, borrowing, or issuing shares to investors.
  • Raising capital via shares avoids debt repayment and interest payments for the company.
  • A share (stock or equity) is the smallest unit of ownership in a company.
  • Equities are considered one of the best long-term investments for wealth generation.
  • Shareholders receive profits via dividends and capital gains, and possess voting rights.
  • The Stock Exchange is the venue where shares are traded.
  • Stock Market Indices (e.g., Dow Jones 30, UK 100) summarize the performance of major groups of stocks.
  • Share prices rise if a company is profitable and expected to remain so, and drop otherwise.
  • A Bull Market is characterized by rising prices; a Bear Market is characterized by falling prices.