What are shares?

If you want to start investing, the stock market is a great first choice.

It's easy to access, low-cost, and can provide great long-term returns.

But what actually is a stock?

What do you get when you buy one?

And where does its value come from?

This guide breaks down all the questions you need answered if you're going to invest in shares.

What is a stock?

A stock is a type of financial security that represents part ownership of a business.

Units of stock are called shares and when you buy a stock you become a shareholder.

As a shareholder, you get to:

• Benefit from capital growth as the business (hopefully) becomes more valuable over time, allowing you to sell your shares for more than you bought them
• Earn additional income in the form of dividends that the company decides to pay
• Vote in AGMs (if you feel like it)

Where does share price come from?

Share price is determined by two things:

• How much investors believe the company is worth (market capitalisation)
• The number of shares that the company is split into (shares outstanding)

Just because Woollies' shares are $30 and Telstra's are around $5, doesn't mean that Woollies is more valuable.

Woolworths has 1.2 billion shares outstanding, while Telstra has over 11 billion.

By multiplying share price by shares outstanding, we can see that Telstra is actually worth almost $18 billion more.

• Woolworths - 1.22 billion x $30.85 per share = $36.92 billion
• Telsta - 11.25 billion x $4.82 per share = $54.15 billion

These share prices change as investors try to estimate how much each business is worth by looking at things like:

• Company profits and growth rates
• Interest rates and inflation
• Consumer behaviour and macroeconomic trends

Why do companies issue shares?

Companies issue shares to raise money.

Instead of borrowing from a bank and paying lots of interest, a company can sell parts of itself to do things like:

• Develop new products or services
• Expand operations
• Pay down debt

Initial Public Offerings (IPOs)

An Initial Public Offering (IPO) is when a company sells shares to the public for the first time.

Before "going public", a company is privately owned - usually by its founders, employees, venture capitalists, or angel investors.

Companies usually do this to broaden their investor base, increase liquidity, and raise more money than would typically be accessible privately.

However, "going public" is not without its disadvantages.

Public companies are required to report financial and other information on a regular basis. This helps investors make informed decisions, but can be a material cost to the business.

Primary and Secondary Markets

The IPO, and any subsequent raisings (called secondary offerings), are the only times investors buy shares from the company itself.

When new shares are created or sold for the first time like this, it's called the primary market. 💰

Every other time you buy or sell shares, you are trading with another investor. This is called the secondary market. 🤝

This is an important distinction to make. It means that after the IPO, the price that a stock trades at is simply what investors agree that it should.

Are shares risky?

Shares are considered a risky asset class.

That's because they are tied directly to the performance of the underlying business.

If a business does poorly, its share price will fall (potentially to $0 if it goes bankrupt).

This is opposed to other asset classes such as bonds, which provide a fixed rate of return through regular payments to the investor.

On the other hand, if a business does well, there is no limit to the potential upside.

This trade-off between risk and return is what makes shares so attractive for a lot of investors.