Investing

What are stocks and shares?

19 November 2020 | Posted by Claro Money
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Buy a small part of a company

What’s it all about?

Owning stocks and shares means you own a small part of a company.

Why should you care?

Stocks and shares make up a significant proportion of many typical investment funds, including pensions and ISAs (Individual Savings Accounts – a tax-free way of saving.)

What will you learn?

You’ll learn about what stocks are, how they work, and what to consider if you want to get in on the action.


What are stocks and shares?

Stocks and shares give you the right to dividends or a share of the profits of a company.


How do stocks and shares work?

Companies sell some of their shares to raise money and avoid borrowing money.

The most easily accessible stocks are from publicly listed companies, like those in the FTSE 100 in the UK or the S&P 500 in the US.

The price of shares goes up and down depending on the behaviour of the market, or how many people are looking to buy and sell.

When more people are looking to buy, the price goes up. The potential returns on the investment in individual shares will depend on the price you buy and sell them for. The higher the selling price compared to the buying price, the higher the profit.

A very simple example would be buying some shares for £10, selling them later for £15 a share, giving a profit, before tax of £5 per share.

In reality, when you’re looking to buy or sell a share on the stock exchange, you’ll be quoted several prices. A ‘bid’ and an ‘offer’ or ‘ask’. The ‘ask’ is the higher of the two prices and the price someone will sell you the share at. The ‘bid’ is what someone will pay you for your share. The difference is called a spread, and this is the profit the broker makes on buying and selling stocks.

Stock prices are forward-looking, which means they reflect how much other investors will pay for a company’s projected cash flow in the future. Lots of factors affect the share price, such as:

Environmental factors – Stock prices can be affected by all sorts of factors, including the economy or the industry conditions in the market. For example, BMW might see a drop in sales if there were a recession and fewer people splashed out on luxury cars.
Competitor factors – The market share of a company can affect the price of the stock. If it’s increasing its share of the market, and future revenue looks good, the share price will reflect this.
Internal factors – Profit margins can also affect cash flow, especially if business costs increase.
Market sentiment – Ultimately, it’s what investors will pay for a stock that will determine the price.


What to consider when investing in stocks

Researching and choosing the right stocks can be time-consuming. Stock prices can go up and down in value quickly, so they are seen as riskier than some other investments. But they usually offer the greatest chance for higher returns in the long-term.

This approach to putting your money in stocks has an impact on your short-term liquidity. It’s a long-term approach: you should be planning to keep hold of your stock for many years, before eventually selling.

However, you can always sell your stocks if you need to, but this could mean you sell for less than you brought them for or for lower levels of return.

There are plenty of great companies to invest in. You don’t have to limit yourself to the UK. But consider that global equities investments – shares in companies listed around the world – can fall and rise purely because of exchange rate fluctuations.

Stocks can reward investors in two ways:

By increasing in value as they attract more people who want to buy them.
By paying out dividends.

Some companies may not pay dividends at all. For example, if they’re reinvesting in the business to build their market-share and or achieve higher profitability. This can be great for the share price, but not so great if you want an investment that pays you regularly. Amazon has not paid out any dividends, despite being one of the most profitable companies in the world. Shareholders have preferred to either sit on a stock which has generated a return of over 30% per year over the last ten years and hold out for those dividend payouts – if they come.

If you receive dividends from your stock investments, you may have to pay tax on your dividend earnings, even if you don’t sell your shares.

Remember, shares can go down in value or become worthless if the company goes bankrupt. A company can also reduce or cancel its dividend payments, leaving you without the regular income you were expecting.

With ethical investing, stocks give you a lot of freedom to choose companies that align with your values. The downside is that the information about a company’s environmental, social and governance performance may not be available or easy to find. The upside is that there are ways to see how your investments align to your values, for example, ESG ratings.

ESG stands for ‘environmental, social, and governance’ and is a way of comparing how ethical or sustainable investments are. There are ratings and reports you can access to learn more. We have a pack on Ethical Investing if you’d like to know more.


Where to get stocks

If you want to buy or sell shares in specific companies, you can go through stockbrokers, securities dealers, banks or retail investor apps and platforms.

Alternatively, if you don’t have the time to research and choose shares, you can still get in on the action by investing in funds that have a portfolio made up of shares. For example, stocks and shares ISAs or pension funds. Many of these now come with ethical investment options.

If you know the industry you want to invest in, but you’re not sure which company to choose ETFs (exchange-traded funds) could be a good bet. ETFs are made up of a collection of asset classes, including stocks. There are different EFTs focused on specific sectors such as green energy.


Key Takeaways

That’s a wrap. Here are the key takeaways from this pack.

Shares are small pieces of a company.
If you invest in them, you can collect some of its earnings through dividends and stand to gain if the share price goes up.
Stocks give you freedom to invest in companies that align with your values, but it can be difficult to get the information you need.
Researching and choosing good companies to invest in can be time-consuming, but you can get in on the action by investing in funds that contain stocks.
Stocks are considered riskier than some other investments, but they also usually offer the greatest chance for higher returns over the long term.

Remember that investment values naturally fluctuate. When investing your capital is at risk.


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