Tag Archives: common shares

STOCK MARKET BASICS FOR NEWBIES – 5

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PREFERRED SHARES

Common shares are only one kind of investment opportunity available on the stock market, and common shares are not the only vehicle that a company has to raise capital. As a company grows and becomes more successful, they may still need to raise more cash in order to finance that growth or acquire new technology or perhaps acquire another company. There are many reasons a company continually needs to reassess their financial situation and look to the stock market for help. Another form of common share called a preferred share may provide an excellent vehicle for both the company and the investor.

A preferred share has a few differences from the other share we have talked about – the common share. A preferred share is still a unit of ownership in the company. But the added benefit includes a fixed dividend on each share. The company promises to pay an established dividend to the shareholder regularly before it pays any dividends out to the common shareholder we talked about earlier. The benefit for the investor is a fixed income or yield. In addition, in the event of any business wind-up, they will pay a preferred shareholder their portion of assets before a common shareholder. There are some accounting advantages for the company to have equity or owners instead of debtors on their books if they borrowed this money instead of creating and selling preferred shares.

Preferred shares may not be the most exciting investment in the world, since their trading price is governed more by what is available in terms of average yield rates than the usual ups and downs of a common share. However, for the investor looking for both safety and yield, they provide a very nice possibility to take part in both areas. We find that preferred shares are most often available for only senior and successful business enterprises. Share prices for preferreds can fluctuate based on the success of the company but most often, by changes in interest rates available to investors.

We will not delve into financial planning, but if your country has any special tax treatments for capital gains or dividend income, you want to be aware of these as they can influence your investment decisions. Find a link to your taxation department and investigate – it could be very advantageous because countries like to promote investment in their local economies.

WHY STOCK PRICES CHANGE

This might be the right place to discuss how and why share prices change. If we return to our initial installment, we talked about the stock market being like an auction. There are buyers and sellers, and they determine the stock price at any given moment. To put it simplistically, buyers think the stock price will go up and sellers usually think the opposite. To put it simply, share prices often anticipate the future financial well-being or hardships of the company. Remember from our previous installments that a company is required to report to its shareholders regularly. The report will review results from the prior quarter or year but also look into the future and project (almost always positive) developments they expect.

Journalists, analysts and others are always looking into the projected health of public companies and expressing an opinion about what they will or will not accomplish. These opinions often fuel the rise or fall in the stock price. When you decide to investigate or buy a company’s stock, you discover that Mr. Google and Facebook, among others, have already learned that about you and begin feeding you all kinds of information. So, why didn’t we both buy Google or Facebook or Microsoft when they were being created in some weird geek’s dorm room? Anyway, as we get more involved in all things “stock market,” we will begin to research and form our own opinions about whether a company represents an excellent investment opportunity. Just remember, you can’t believe everything you read, so be cautious about the source of the information. The price of a common stock usually represents what other investors think will happen in the future. Yes, there are both negative (I want to sell) and positive (I want to buy) sentiments out there – that’s what makes it an auction. Your job is to decide which side of the fence you sit on. If there was only one correct answer, this whole investing thing would be a piece of cake.

There are no guarantees in the stock market, so doing your own research or looking to a trusted source of research is absolutely vital to your success as an investor.

There are a number of other investment vehicles available and we will look into these in future installments. If this is your first exposure to this series, you will want to review our previous articles and don’t be afraid to comment or send this to friends. You can also contact me if you have questions with this one proviso, I am not offering specific investment advice but hope that you can benefit from having some basic knowledge about how the stock market works.

STOCK MARKET BASICS FOR NEWBIES – 4

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WHY SHOULD I INVEST IN THE STOCK MARKET?

Why would someone invest in the stock market? This is an excellent question, and the answer is to get your money working for you. There are a couple of very important ways that you make money with owning common shares. First is the potential for a capital gain if the shares go up and you sell them for a profit. Second, is the possibility that the company will pay out a dividend to its shareholders. Companies can share their profits with their owners, and many senior companies do that every quarter or sometimes monthly. They announce the amount and payment date of their dividend payout in advance, which brings us to the topic of “yield.”

Yield is the amount of money you earn each year by owning the stock of a company. We always express a dividend in terms of dollars and cents per share. You can easily calculate your “yield” as a percentage using the dividend amount and the price you paid for the stock. Please remember that a company can raise or lower the dividend amount as financial conditions change for them. Your yield is determined by the price you paid, not what the stock is currently trading for on the market. Let’s look at our company Orange and see how this works. We assume you bought the stock initially for 10.00 per share and let’s pretend that the company announces a dividend of .50 per share annually. It doesn’t take a lot of math to figure out that the “yield or earning” on your shares is 5%. If someone else bought the stock on the market for a higher price, then naturally their yield would be less.

Let’s return to the opening line of this article- “why would someone invest in the stock market?” We will introduce something here that may be of interest–the Rule of 72. Many people do not want to take the time and effort to learn a few basic investment procedures and tell others it is too complicated or too risky, etc. Let’s add some reality to that argument. Suppose that someone has $10,000.00 available to put away for retirement and they are only comfortable putting it into a savings account at their financial institution. What is the current rate for savings accounts? At the time of writing, it is around 1%. The Rule of 72 states that if you divide 72 by the rate of return (in this case, 1%) the result is the number of years it will take to double your initial investment. SARCASM ALERT: For the safety conscious non-risker takers, add 72 to your current age and you will have turned your $10,000.00 into $20,000.00. Fantastic! You have doubled your money. By the way, we have not considered the ravages of inflation or taxes, but in only 72 years you will have twice as much money assuming you withdraw nothing during that time.

Let’s go back to our example of Orange in which we determined that if you bought the stock at 10.00 and receive a .50 dividend each year for a return of 5% how would we fare with the Rule of 72? We divide 72 by 5 and learn that if we do not withdraw any of the earnings, our money will double in 14.4 years. You can do the calculations yourself for different scenarios. That alone is reason to give serious consideration to investing in stocks. This process also works if you only consider the growth in the stock market itself if you own the right investments. We will cover some of those types of investments later but consider this: The 25-year average annualized return for the S&P 500 from 1994 through 2018 was 8.52%. If you had invested in an index fund that tracks the S&P 500 in 1994 and you never withdrew the money, you would have average returns of 8.52% per year. At that rate, expect to double your money about every 8.45 years. For those people who already follow the market a bit–this includes the fact that it had many swings in value both up and down during that period.

OK, enough math for today–your head hurts and this was precisely the stuff you wanted to avoid – right? Common stocks are not the only investment available on the market, and we have already alluded to at least one other. We will move on to some of these possibilities next time.

If this is your first exposure to this series, you might find it helpful to start at the beginning with our bite-sized lessons about investing and the stock market. You can also share this with friends and on any social media platforms if you want to.