When you buy shares you become a partial owner of the company, shareholders are not lending the company money they are the company. This means that the value of your investment goes up as the value of the company rises on the market. It also brings a share in any profits that might be distributed through dividends. As a shareholder you have a right to vote on key decisions when they arise.
Dividends are payments made to shareholders from a company’s profits but not all businesses pay dividends, the directors may decide to keep some cash for development. UK company dividends are usually paid twice yearly and shareholders can either take cash or choose to use the money to buy more shares in the company.
One of the big positives for those investing over long term is reinvested dividends which allows you to benefit from compounding.
If you want to value shares, then you need to do so using one of the typical valuation methods. The most commonly used is the price-to-earnings ratio or P/E. This compares a company's share price to the profits it makes per share.
A company with a P/E of 10 is being valued at a lower level than a company with a P/E of 20. This maybe because it is judged to have poor growth prospects or because the market has overlooked it. Always compare share valuations to the kind of company that it is, its peers and the market as a whole.
What makes shares go up or down?
Over the long term, the single most important factor is rising profits, or the expectation of them. Several other factors influence price, though.
If the overall stock market is rising, many shares will be dragged up in its wake and if stockbrokers are optimistic about a particular sector – property for example – then shares in companies in the property sector will benefit.
Remember that the market looks at the future, not the past, so brokers and big investors are far more interested in how a company is expected to do in the years ahead than how it performed last year. Sentiment is a key driver when it comes to share prices. If the market doesn't like a company for whatever reason, its share price can remain depressed even as it continues to grow profits.
In contrast, the market may have decided that it loves a company - these are often called story stocks - and rate it more highly than you would expect. These anomalies in valuation can provide opportunities for investors.
Should you invest in funds or investment trusts?
Picking individual shares is not for everyone. You need to make sure you research companies very carefully, learn to understand how to read their balance sheets and financial statistics and don’t just get swept along by what the hot tips of the moment are. The classic share investor’s mistake is to buy too few different companies. A report by specialist magazine Investors Chronicle said the ideal number of shares for a portfolio is 15, spread across different sectors.
A simple way around this is to invest in either active funds or investment trusts, where a fund manager chooses a basket of shares for you, or in passive tracker funds or exchange traded funds, which follow an index up or down. Fund managers will tell you that the advantage of an active fund is their expertise but you actually have to choose the right manager to benefit from this. Many consistently fail to beat their benchmark and still levy their fees - a handful do actually outperform year after year.
Of course, investing in shares and funds does not have to be mutually exclusive. One investing idea is to build a core portfolio of funds and use a smaller part of your portfolio to add some spice by dabbling in picking individual shares.
How do I buy and sell shares?
When a company first floats on the stock market, such as Royal Mail did, it is sometimes possible to apply for shares directly from that firm. This is known as an Initial Public Offering (IPO).
Generally, however, shares are bought through a stockbroker or a financial services firm. Many of these firms allow investors to buy and sell shares online simply by filling out an online form. Investors can also buy and sell shares over the phone by ringing a stockbroker or a financial adviser.
The best bet for a DIY investor is one of the many investing platforms available, ranging from those that offer funds only, to those that allow you to invest across shares, funds, investment trusts, bonds and more.
These will allow you to set up an account online and then pay in a lump sum to invest how you choose, or sign up for regular direct debit monthly payments into a selection of investments - or do both. Most platforms are very simple to use and easy to get used to. They will offer varying degrees of tips, analysis, tools and service.
How do I choose which stockbroker to use?
This depends on what service you want. Investors who just want to trade online may be tempted to seek out the cheapest provider. That is fine, as long as the firm is regulated by the Financial Conduct Authority.
Some investors may prefer dealing with a firm whose name they recognise and websites differ too, so it is important to find one that is easy to navigate. Investors who are looking for advice as well as trading services should talk to a range of brokers before making any firm decision. Look for a broker that you trust and respect.
How long should I hold shares?
Shareholders can be divided into traders and investors. Traders buy and sell shares frequently, hoping to make quick profits. Investors hold on to their shares for at least five years and generally a lot longer.
Long-term investment in shares should prove rewarding, particularly when investors reinvest their dividends to acquire more shares. Sometimes, however, if a share has risen significantly, investors might choose to sell some of their stock. This is known as top-slicing.
What should I consider before buying?
The first point to consider is whether you can afford to lose the money. Shares are not risk-free investments, so if you need the cash to pay the mortgage or school fees, tread very carefully. It is also useful to do your own research.
Read a company’s latest annual report, look at its website and seek advice from your broker. Think about your investment aims and your time horizon, too. This will influence the type of shares that you want to buy. Big, stable companies with decent dividends tend to deliver long-term rewards. Smaller, riskier companies can offer short-term excitement.
Finally, if you do fancy trading, rather than investing, it can be helpful to set price targets so that you sell at least some of your shares once you have made a profit.
For more information on Stocks and Shares, please contact us.