What happens when I buy a share?
Each company has a limited number of shares in circulation at any one time. Many years ago, a physical share certificate would be issued to show the entitlement, but now most ownership records are held electronically. It is the responsibility of the company – ‘the issuer’ – to maintain an up to date record of the owners of these shares. Although this can be done in-house, typically the task is passed to a specialist firm of registrars and every time you buy or sell a share, the register needs to be updated.
Often when you buy shares as a retail customer, these will be held on your behalf by a nominee. At Dabbl, our nominee is Winterflood Securities, part of Close Brothers, a 140- year-old Merchant Bank based in London. This helps keep the cost of buying and selling shares low, but when there’s a dividend to pay or a rights issue to participate in, the issuer will be able to contact you via the details held with the nominee.
When you buy a share, in addition to any charges by the brokers and exchanges – known as transaction costs – the government also collects a levy known as “Stamp Duty”. This is 0.5% of the transaction value. Your stock broker will collect this automatically and pay the government on your behalf.
What happens when I sell a share?
Selling shares is essentially the reverse process. The broker will find a buyer for your shares, typically via what is known as a market maker. Settlement from the sale of shares currently works on a two-day basis to allow the transaction to be processed and validated, so the money generated will be back on your account two working days after your broker makes the sale.
Again, there are transaction fees to pay, but unlike when you buy shares, the government doesn’t apply a tax.
What is a share price?
A company’s share price reflects what people believe the business as a whole to be worth, divided by the number of shares in circulation. So, if the company is thought to be worth £1 million and there are 1 million shares in circulation, the price of each share should be £1.
That value will be figured out by looking at various items including fixed assets like buildings or machinery, cash held in the bank and also a forecast of the profits the company is expected to make in the future.
Because of this, we have a wide range of factors that can affect a company’s share price. Let’s take some basic examples for a large chain of supermarkets – a change in consumer habits, so buying more from independent stores – could push down expectations of future profits, which in turn would see the share price side. Equally, rising commercial property values would see the stores they own being worth more, so the share price may rise. Also, an unexpected demand for cash – maybe many staff have been underpaid for years – would see a lot of money flowing out of the company quickly and again this could hit the overall valuation.
It’s not always this simple and the market isn’t always as rational as we have laid out here. The price of a share can also be influenced simply because it’s in demand – or plain out of favour – with investors.
What’s a dividend?
Companies aim to make money for their shareholders through two routes. The first is capital appreciation – so that’s the overall value of the company increasing, meaning that the share price rises. The second is through the payment of a dividend, which is paying some of the surplus cash back to investors.
Dividend policies vary between companies. Some will commit to pay no dividend at all, with the surplus cash being reinvested into projects that should further growth or simply being held in the bank. Either way, the intention is to drive the share price higher.
Other companies may look to pay back as much as they can to investors, either through dividends or by what is called a share buy-back. The company buys its own shares then cancels these. You have a smaller number of shares in circulation but the company is worth the same amount, so the value of each share rises.
The dividend essentially transfers money from the company to investors. This means the company is worth less than before as a result, but investors then have the cash to decide what to do with it. Maybe buy more of the company’s shares, buy other shares or use this money as if it were income.
What’s a rights issue?
A rights issue is the reverse of a share buyback, which we discussed above. Sometimes a company will need to raise more money and there are various ways to do this. They could borrow from banks, sell existing assets or sell new shares in the business. This last route is known as a rights issue because for every share you own, you will have the right to buy a corresponding number of new shares. It’s important to remember that you don’t have to participate in the rights issue if you don’t want to, but in percentage terms, you will own less of the company after the issue has taken place.
What is diversification and why should I think about it when buying shares?
We have designed the Dabbl app to make it easy for you to understand who owns the brands that surround you on an everyday basis – and buy shares in the appropriate companies if you want to. However, as you start building a portfolio of shares in different companies, it’s worth understanding the concept of diversification – or to put it another way, not having all your eggs in one basket.
Buying shares in several companies means that you’re spreading the risk around. Going back to our example of the supermarkets, if one retailer is facing an unexpected bill for unpaid wages, it’s unlikely that their competitors will be in the same situation. Therefore, owning shares in two supermarkets should be less risky than just owning shares in one. However, the example of increased demand for shopping at independent stores would potentially hit all the supermarkets. That means looking at other sectors is important too.
Owning a supermarket and a food manufacturer gives some diversification, but there’s still overlap. Falling demand for cakes means fewer are baked and fewer are sold – both the baker and the retailer lose out. However, pick a supermarket and a social media platform and the two have very little in common.
The concept of diversification is a very important one to understand at the start of the investing journey. It’s called Portfolio Theory and plenty has been written about it, but put simply, the more stocks you own, the more diversified your risk is.
