Understanding the basics of investing

Do you speak finance? It sometimes feels like financial professionals and seasoned investors are speaking a completely different language, filled with unfamiliar slang and confusing terms. From IPOs to privatisations; dividends and capital growth – it’s always worth brushing up on the basics when you’re investing in the stock market.

Read on for a refresher on some of the basics of investing…

What is a stock market?

The key is in the name: a stock market is a market where shares are bought and sold. It’s also sometimes called an exchange because shares are exchanged for money or other shares. This can be done in person on the trading room floor, or it can be done online.

There is a stock market in just about every capital city in the world, and the exchange building typically forms the centre of that country’s financial services sector. In London, the stock exchange is located right smack in the centre of the City, while in New York it's on Wall Street.

What is a listed company?

A listed company is any company whose shares can be traded on a stock exchange. Companies make shares available to the public when they want to raise funds to grow their business. People who buy shares in a company become part-owners. Think of it as going into a business with friends you never met. They run the company, you provide the capital and share in the profits and growth.

When a private company decides to become public, it undergoes an Initial Public Offering (IPO), which involves listing the company on one or more stock exchanges. Once the company has been listed on an exchange, anyone can buy and sell shares of the business.

Listed companies are subject to strict regulation, which involves maintaining a high level of transparency. Any information about board changes, management moves, new investment strategies, or potential mergers and acquisitions must be reported publicly so that investors can make the most informed decision about their money.

What is a share?

A share is a portion of a listed company which can be bought and sold on the stock market. The total value of a company’s shares will reflect the total value of the company. So, if Company A is valued at £100 million and it has 100 million shares, each share will be worth £1. Therefore, if you invest £100 in Company A’s stock, you’ll own 100 shares in the company.

Most companies issue common shares, which can be bought by anyone who has access to the internet and a few extra pounds. The size of the company will dictate the value of each share. The cheapest stocks can sell for as little as one penny, while the most expensive shares can sell for more than £100 each.

As the name suggests, when you buy a share, you own a share of the company. If the company does well, the share price will go up and you will be able to sell your holding at a profit. If the company does poorly, the share price will fall, and you may lose value on your investment.

How do shares make money?

Shares make money in two ways: income and growth.

Income takes the form of dividends, which is when a share of the profit the company made gets paid out to shareholders. The company does this to shore up support among its shareholders by offering an incentive to hold on to the shares. Dividends are paid at the company’s discretion, and they can be a one-off payment or a regular occurrence. These dividends can then be reinvested or withdrawn, without having to give up your stake in the company. When you use your dividends to buy more shares in the company, your investment has an opportunity to compound.

Growth is when the company’s value increases, and the share price increases as a result. As a shareholder, you have some ownership in the company which means that when the company performs well, your investment will too.

Say you bought 100 shares in Company A at £1 per share, then the company introduces a new product which increases its value by 50%; suddenly your share of the business would be worth £150, or £1.50 per share. You can then sell all or some of your shares to release their value, or you can choose to stick with Company A for a little bit longer in the hopes of getting an even bigger return.

Selling a share

To make money from the growth of a share, you must sell it. While you’re holding on to the share, any growth you see is only on paper. It’s only once the share is sold, and the fees and taxes are paid that you know exactly how much profit you made on your investment.

As long as the company is still publicly listed on a stock exchange, this should be a relatively straightforward process. Once you sell your stock, you will be divested from the business, although you can of course choose to reinvest in the company at any point in the future.

When listed companies fold

Although listed companies are highly regulated, they are still subject to the same challenges as ordinary companies. That means sometimes things don’t work out and companies fail.

A listed company could go into liquidation, which will result in it being taken off the exchange and entering into insolvency proceedings. In this case, shareholders will be classified as creditors and may not be able to recoup the total value of their capital investment.

The company could also enter into a merger or acquisition. Shareholders will be given plenty of notice of this and will usually be given the option of owning shares in the new entity.

The company could opt to go private. This usually only happens when large scale institutional investors step in and offer to buy out the shareholders, often at a premium. Once the shareholders agree to the terms of the privatisation, the company will be delisted. When that happens, the company will have to buy back your share of the ownership on an agreed-upon price decided at the shareholder meeting.