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All you need to know about investing in shares and ETFs

At ThinkMarkets, we would like you to learn what investing is all about, and why it’s so important to take action now and build your financial future. Putting your money in assets, like company shares or exchange-traded funds (ETFs), will help you generate additional income and increase your wealth.

What is a share?

A financial instrument that represents a share in the ownership of a company.

Who is a shareholder?

The legal owner of a company’s shares. Shares give holders rights to vote on important company decisions and to receive dividends.

What is a dividend?

A payment to shareholders out of the company’s resources. This is usually a cash payment, but there are other types of dividends.

What is the ruling price?

It’s the last price at which a trade of those shares took place. This is the price quoted when we want to know what a company’s share price is.

Why own shares?

Shares split a company into lots of little units that are each worth a small fraction of the total value of the company. People who own them are entitled to get voting rights and dividends. Share prices go up and down on the stock market as people change their views about the value of a company. Shareholders can also earn profit by buying and selling their shares.

How are companies valued?

A company’s value is all about its future potential profit. The reason people take risk by buying shares is because they see the prospect for future returns that justify it.

How do shares differ from other investments?

Returns are quite different from other assets such as owning property or depositing money in a bank account. Unlike with bank deposits or bonds, in the case of shares, there are no guarantees for future returns.  Shares tend to be the most volatile of the main types of investment. The reason people take the risk of investing in shares is that they expect the share prices at which they are traded to appreciate over time. Share prices, over the long run, tend to outperform other less volatile asset classes, such as cash or property.

How to read share price graphs?

A share price graph shows the ruling prices and how they have changed over time. Usually, the prices shown in graphs are the closing prices for each day, though you can also choose to display intra-day graphs that show the prices during the course of a day. Along the horizontal axis is the time scale you want to chart. On the Y axis, is the share price. Share price graphs are useful for tracking how a share has been performing.

What is momentum investing?

Momentum investing works on the assumption that the current trend of share price movement will continue in the same direction.

What is value investing?

A value investor is seeking to invest in shares that are historically cheap or undervalued compared to their earnings potential, expecting the price to appreciate or resume an upward trend.

How are shares priced?

Shares are quoted at their ruling price, which is the price at which the most recent transaction took place. A transaction happens when a buyer and seller agree to exchange a share at a certain price. Before that, buyers and sellers post prices that they would be willing to trade at. The prices are determined by the rules of supply and demand and market forces that affect the prices of securities.

What is the closing price?

The last ruling price of the day. On the JSE, this is set through a daily closing auction.

What is the bid price?

This is the price you are willing to pay for a share. You specify a number of shares and a price and that bid is placed in the market. When you bid, you show your intent to buy.

What is the offer price?

This is the price at which you indicate that you are willing to sell a share. You specify how many shares you are willing to sell at that price. Sometimes this is called an “ask” price. When you offer, you intend to sell.

What is a limit order?

This is a bid or offer with a specific maximum price, if you are buying, or minimum price, if you are selling. You place it in the market, and it is fulfilled if a counterparty agrees to match or better your limit price. If no one matches the price, the order will expire unfulfilled.

What is a market order?

In contrast to a limit order, this executes a trade at whatever the best price in the market is at the time.

What is a spread?

The spread is the difference between the best bid price and best offer price at any one point in time.

What do we mean by the depth of the market?

It’s a measure of the supply and demand for tradeable assets, such as shares and indicates the liquidity of a certain market. It's determined by the number of open buy and sell orders for a given share on a specific exchange. The greater the quantity of those orders, the "deeper", or more liquid, the market.

What is the difference between a market order and a limit order?

A market order simply states that you are willing to buy or sell at the best price in the market. The advantage is that it is quick, and you have certainty of the transaction being filled.
 
A limit order places a bid or offer into the market at a specific price. The risk is that it may never be filled if no one else in the market places a matching bid or offer. Limit orders are not ideal if it's urgent for you to complete the transaction. However, limit orders can get you better prices.

What are Exchange Traded Funds (ETFs)?

These trade just like normal shares, but that they are a share in a basket of other instruments. Often the portfolio consists of shares of companies listed on the JSE but can also be foreign companies, commodities, currencies, and other instruments. They allow you to diversify your exposure and are a cost-effective way of building a portfolio. They are low to medium risk.

What are Exchange Traded Notes (ETNs)?

These are like ETFs but instead of comprising of a portfolio of assets, these notes are guaranteed by a highly rated financial institution to pay a return, which is linked to a reference asset. ETNs do have credit risk to the institution that gives the guarantee of the payout. They are riskier than ETFs because of that element of credit risk.

What are the reasons for investing in shares?

We invest in shares because we want to generate a return on our savings. The stock market is a very important source of investment returns across the economy and by having a stockbroking account, you get to tap into that market directly. Shares give you two main kinds of returns: cash in the form of dividends, and capital gains when the value of your shares goes up.

What is the difference between dividend and capital gain?

A dividend is a payment to shareholders out of the company’s resources. This is usually in cash, but there can be other types. If you need income, investing in companies with a good track record of paying dividends is a good way to secure it.
 
Capital gain is the appreciation in the value of shares over time. This can be a much more important source of returns. In effect, you get that cash when you sell the shares at a higher price.

When does a company pay out dividends?

A company pays dividends out of the equity that it holds on its balance sheet. Equity comes from two sources: the cash shareholders put into a company when it’s set up, and what it sets aside from the profit that it generates. A company that doesn’t need capital can opt to pay out the cash to shareholders. We call these companies “ex-growth”. Utility companies and traditional telecom companies often fall into this category.

How to pick the type of company to invest in?

The answer depends on the returns you are seeking to generate. If you are relying on your savings to generate an income, for instance in retirement, the best strategy is to invest in dividend-paying stocks.
 
If, on the other hand, you are building a share portfolio for the long term, it makes more sense to invest in growth companies that have a potential to build their value over time. Companies focused on growth may pay out some dividends just to signal their health to the market but retain a lot of earnings to fund their growth.

What is the Volume-Weighted Average Price?

It’s the price of shares traded weighted by the volumes of trade at each price point during the day. It’s a better indication of the current value of shares than the ruling price.

What is the best way to manage risk?

In investing, exposing yourself to risk is essential because it is the key to returns. But you want to get that exposure in the most efficient way possible. The way to get the most efficient exposure is to diversify the shares you hold. What you want is to maximise returns per unit of volatility.

What are the risk factors to consider with share investing?

Size of company
Big companies tend to be less risky than small companies. This is because they usually have a more diverse earnings base. If one part underperforms it can be compensated for by better-performing parts.
 
Proportion of fixed costs
Companies with high fixed costs, like big factories, are unable to respond quickly when their revenues turn down. Mining companies are a good example. Even if they take the drastic step of mothballing a mine, there are still ongoing costs.
 
Amount of borrowing
Companies that have a lot of debt on their balance sheets tend to be riskier than companies with less. That is because debt repayments must be made no matter what the state of the economy.
 
Liquidity of the share in the market
If there is very little liquidity in a share, usually because it’s very small, then it can sometimes take time to sell a stake, or you have to take a big discount to do so.

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