Oran Hall | Benefits of owning shares on the market
Owning shares in a company that trades on the stock exchange has several benefits, not all of which are financial. This is particularly true of companies that are profitable.
One benefit that all shareholders cherish is the ability of the price of the stock to appreciate. When the price of the stock increases, primarily due to the company making good profits on a sustained basis, the value of the investment increases, thereby presenting the opportunity for the investor to realise a profit on the investment.
Notwithstanding the likelihood of the price falling due to fluctuations in the market and the profits of the company, holding the stock for a long time presents opportunities to derive returns that exceed the rate of inflation. This is good news as it means that this positive real return helps to protect the purchasing power of the investor.
Another benefit to the investor is that the investor who chooses to borrow against the value of the shares is able to borrow more if necessary as the price of the stock appreciates, so the shareholder does not have to worry about finding additional collateral as would likely happen when the price falls.
Share ownership also generates income to shareholders if the company makes profits consistently. The portion of the profit that is distributed is called dividends. There are several factors which determine if the directors decide to recommend the payment of a dividend. In addition to net profit in the current year, the level of retained earnings, the working capital position of the company, and plans for expansion of the company are some other considerations.
Companies also distribute income to shareholders in the form of a capital distribution, which is not paid as often as a cash dividend. It is generally paid when a company makes a profit from the sale of an asset and opts to distribute some of it to the shareholders.
Shareholders may also receive stock bonuses from a profitable company. This distribution is in the form of new shares in proportion to the amount of shares owned by each shareholder.
Shareholders do not pay cash for these shares. They are effectively paid for from undistributed shareholders’ funds. Shareholders can sell them, but their relative share of the ownership of the company will be reduced.
Sometimes companies wanting to raise new capital may issue new shares by way of a rights issue. In this case, shareholders are given the right to buy new shares ahead of others and generally at a price that is below the market price. Shareholders who take up all of their rights do not risk a dilution of their shareholding in the company, but there are cases in which they may renounce their rights and sell them for their intrinsic value, which is not generally much, and may thus see a reduction in their share of the equity of the company.
The liability of shareholders is limited, meaning that they do not stand to lose their personal assets in the event of the company falling upon hard times, in which case, they lose only what they have invested in it. If a company is liquidated, the shareholder is entitled to a share of the residue, if any, after all debts and obligations have been cleared.
Share ownership gives shareholders a voice in the running of the company as they are able to make decisions by voting at annual general meetings and extraordinary shareholders’ meetings.
These include who should be the directors and auditors, the payment of dividends and other distributions. It is not unusual for there to be robust discussion at some of these meetings.
Element of public participation
When companies sell shares to the public, they allow even people with limited resources to invest in them. Investors are able to participate in companies in several sectors of the economy and thereby participate in the growth of the national economy as well as the economies of other countries without concerning themselves with the day-to-day management of the companies.
At the same time, they are also able to spread their risk through diversification by directly investing in as many companies as they can in as many industries as they can, or indirectly, by investing in mutual funds, unit trusts, and other pooled funds that invest in ordinary shares.
Oran A. Hall, principal author of ‘ The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel.