Introduction to Shares: The Basics

2015-01-09 12:24

So, we all heard about shares and stockmarkets and The JSE and Bulls and Bears, but what do they all mean. Here we will give a briefly explain what they are.

What is the JSE?

The Johannesburg Stock Exchange, now called the JSE Securities Exchange was founded in 1887 and is the largest in Africa. The JSE provides the marketplace for purchase and sale of listed shares. It also provides a mechanism for companies to raise capital needed for expansion and growth by issuing new shares to shareholders.

What is a share?

A share is exactly what the name implies: it gives the owner a share in the underlying company. It also gives the shareholder voting powers at general meetings. The company belongs to its shareholders. The shareholder therefore has a (limited) say in the management of the company. Shareholders appoint the directors who in turn appoint the management. The management is responsible for the daily running of the business and also decides over the payment of dividends.

When a share is bought on the stock exchange, the proceeds go to the seller and not to the company. The buyer therefore obtains the seller's interest in the company as well as all the associated rights and privileges.

There are different types of shares:

* Ordinary shares, that rank after debt holders and preference shares when a company is liquidated.

* Preference share, have the first right to receive a dividend, if a dividend is declared. This dividend never varies and is a fixed percentage of the share price. Preference shares normally carry no voting rights.

* Cumulative preference shares have their dividend accumulate in years when a loss is made and have to be paid in future years.

* Convertible preference shares are convertible into ordinary shares at a fixed price.

How are prices determined on the Stock Market?

Prices of shares traded on the stock exchange are governed by supply and demand. If a company is more profitable (relative to other companies in the same sector), there is a greater demand for its shares with a resultant increased price. The opposite is true where a company shows weak results or experiences financial problems.

Prices are also influenced by the relative attractiveness of expected returns in the equity market relative to other asset classes. The share price reflects the expected future returns of the share, including dividend income and capital growth. Earnings are the amount of money that a company earns after paying for all its costs before tax. This money is reinvested in the business, paid in corporate tax, including secondary tax on companies and to pay the shareholders a dividend.

The JSE used to be an open outcry exchange in the old days where dealers shouted their buying and selling prices. The open outcry trading floor was closed on 7 June 1996 and replaced by an order driven, centralised, automated trading system known as the Johannesburg Equities Trading (JET) system. Clients using an online trading platform like Sanlam iTrade will have their orders routed directly into JET within seconds.

Why invest in shares?

An investor invests in shares for capital appreciation in the share price or value and for dividend income. Dividends are usually paid every six months if the company is profitable and if it does not need to invest all the profits in capital projects.

Shares are risky investments, but only if you invest in risky shares or look at the short term. The JSE All Share Index has never had a negative return over any 5-year period in the last 50 years.

Let’s look at SAB Miller as an example, a very good share, but by no means the top performer. If you invested R1000 in the share ten years ago instead of just buying cases of beer, you will have R10 000 now. That is a return of 27% per year and includes the decline in share prices in 2008.

What is a Bull Market and a Bear Market?

The terminology evolved because of the way each kills or attacks. A bull strikes upward with its horns to kill and a bear slams down with its paws while standing upright. Up-trends are therefore called Bull markets and down trends are called Bear markets.

Warren Buffet, one of the gurus of the investment world said: “I made my first investment at age eleven. I was wasting my life up until then.”

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