What are shares?
What is the function of shares for companies and for investing? How does a share price come about and where do you buy shares? This article provides answers to these and other questions.
The basics in brief
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1. Basics
Shares are share certificates in a company. Companies issue shares to finance themselves by raising equity capital. Anyone who buys a share thereby becomes a shareholder in the company. They then participate in the assets, profits and losses of the company. The share of ownership in the company results from the number of shares held in relation to the total number of share certificates issued by the company. The number of all issued shares multiplied by the share price results in the company's market capitalisation.
Shares are primarily bought and sold on stock exchanges (such as Bolsa de Madrid, Gettex or Xetra). Their price is primarily determined by supply and demand. A trade takes place when the asking price of a potential seller (share owner) matches the amount a buyer is willing to pay.
How does the share price come about?
There is a connection between a company's share price and the market's general expectation of its future economic success.
In principle, share prices fall when supply is higher than demand and shareholders start selling shares. Conversely, share prices rise when demand is higher than supply. Important external factors that can also influence the price include economic factors, industry trends and general market sentiment.
The market efficiency hypothesis assumes that all historical and available information is already priced into the share price. This means, for example, that when company news about profitability or a change in management becomes known, this will be immediately reflected in the share price during open hours on the stock exchange.
Investors make their own individual assessments of a share, some of which differ from one another. Before making an investment decision, some use key figures, among other things, to evaluate the performance of companies. In this way, they form a judgement as to whether a share is under or over-valued at a given point in time, for example, in terms of the ratio of share price to expected profit (forward-looking price-earnings ratio). If investors decide to buy or sell and place a corresponding order, this will also be reflected in the share price.
Why buy shares?
Buying shares can provide returns. These can come from two sources: On the one hand, they come from an increase in the share price, and on the other hand from the distribution of dividends.
In the long term, higher returns can be achieved with shares than with many other asset classes. The higher return of shares compared to other asset classes is also called risk premium, because higher risks have to be accepted. The prices of shares fluctuate more than those of other asset classes, such as bonds. The technical term for how much the price of an asset fluctuates is volatility. Particularly when buying individual shares, there is the potential risk of a total loss of the money invested.
How to buy shares?
Investors can buy shares in individual companies via a stock exchange or a broker or they can invest in baskets of shares via funds (actively managed funds, ETFs). When buying one share, the risk is concentrated in just one company. By investing in several shares, particularly from different sectors and/or regions, or by buying units of a fund, one's risk can be spread (diversification).
The pursuit of diversification takes into account the philosophy of Nobel Prize winner Harry Markowitz: "Never put all your eggs in one basket."
2. Types of shares and shareholder rights
With the purchase of shares, shareholders acquire various rights. In principle, shareholders receive the right to participate in the annual general meeting of the public limited company. Here, among other things, decisions are made on whether and how the profit of the public limited company is distributed, for example in the form of a dividend. In addition, decisions on takeovers by or of other companies are made at general meetings. In certain cases, important personnel decisions are also made and administrative and supervisory boards are voted out or confirmed by shareholders.
Other rights include:
Right to information - Shareholders must be informed about all relevant processes in the public limited company.
Subscription right - In the event of a capital increase, shareholders have the right to acquire additional shares, if necessary, in order to counteract a dilution of their own shareholding.
Right to pro rata liquidation proceeds - Shareholders have the right to participate financially in proportion to their shares in the sale of the company in the event of liquidation.
In public limited companies in most countries, a distinction is made between two classes of shares ordinary and preference shares. Ordinary shares give the shareholder voting rights per share held, whereas preference shares are preferred in the distribution of dividends but do not give the shareholder voting rights.
Emanuel Eisel
Emanuel was Head of Capital Markets at Scalable Capital until March 2022. He holds an M.Sc. in Business Administration from the University of Hamburg and spent parts of his studies at Boston University in den USA.
