A share (or stock as they call them in the USA) is part ownership of a company. To truly understand what a share is (and how it works) – you need to understand what a company is and how they work.
I don’t own shares
You might say – this doesn’t apply to me as I don’t own shares. But if you have a job there is a good chance your Super fund is invested in shares (in another post I will explain about Managed Funds and how this works).
What is a company?
A COMPANY IN A NUTSHELL
My definition: A company is separate legal entity (or person) that doesn’t die (it can be closed though). The company is run by director(s) (who can be held responsible if they stuff up). The shareholders of the company have limited liability and benefit from company profits paid by dividends.
Directors are individuals (real people!) and can also be shareholders. Shareholders can be individuals or entities (such as other companies, managed funds, etc.)
The END (well not really)
The above explains a company as simply as I can.
Below I explain a bit more about types of companies and a bit more about some of the bolded words in my definition.
Types of Companies
Public: In Australia there are public companies (Like Woolworths Ltd) which have Ltd or Limited after their name.
Private: There are also a lot more private companies which have Pty Ltd or Proprietary Limited after their name
Whats the difference – public/private?
A private company (Pty Ltd) can have a maximum of 50 shareholders and can’t sell their shares to the general public.
Private companies can range from:
Mum and dad company (with a $1 share owned by each Mum and Dad = $2 Share Capital) to:
Large private company with a CEO, board, millions in share capital owned by various entities and individuals.
Public: A public company (either listed or unlisted) can have unlimited shareholders and can offer their shares to the public.
What about the stock exchange – listed companies?
A public company can request to the stock exchange to ’list’ (i.e. allow trading of) their company. The Australian Stock Exchange(ASX) requires a lot of information and ongoing disclosure such as providing accounts, annoucements and other forms to the ASX.
Why bother listing?
The main benefit of listing your company on the stock exchange is getting capital to expand the company (when you float). You might offer $50 million shares to the public for $2 each. So there can be big bucks in listing on the stock exchange.
The limited part (Pty Ltd or Ltd) means that people can’t sue you as the investor/shareholder.
Your shareholder losses are usually limited to what you paid for the shares (the exception is ‘partly paid’ shares but these are rare)
If the company goes bust then all your have lost is the price you paid for the
shares (the creditors cannot sue you personally with a company like they could if you were a sole trader/partnership).
Ordinary Shareholder are entitled to receive dividends. A Dividend is a share of the companies profits.
Not all companies pay dividends (some like Google in USA choose to reinvest their profits into the company to make more profits in the future). If this grows the company then hopefully the company’s share price will increases (and your shares are more valuable).
Shares can be owned directly or indirectly (via a Managed Fund that your super fund might be invested in).
Managed Funds - simple definition & how they work
Managed Funds are a way that shareholders can own shares indirectly and are the default investment option for a super fund.
For example you bought 1,000 units (either in your super fund or in your own name) in XYZ Managed Fund for $1 each = $1,000.
XYZ has $1 million units x $1 = $1,000,000 in total to invest. So your 1,000 units/1million units total = 0.1% (or one thousandth) of all units.
XYZ will have investment rules about what it can invest in. ie. XYZ Balanced Fund – might invest 70% in Cash to earn interest and 30% in Shares.
XYZ Industrial Real Estate – in industrial real estate properties and XYZ Growth might invest 100% in shares, etc., etc.
Then when the profit is paid out (called a distribution) you get a slice of the pie (in this case 0.1%).