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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

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Introduction

How do I invest in the stock market without losing my shirt? I don’t understand how all that stock market stuff works so I’d better stay away from it. I don’t know how to buy or sell stocks and bonds so I’ll let my investment advisor make those decisions. If I just go into the bank and tell them I want to invest my money, they’ll know what to do – right?

The fear of the unknown costs all of us opportunity, time and money. If you do an online search for “investing,” “stock market,” or some other similar term in the hopes of learning how it all works, you will usually be disappointed. Why? Because most search terms will turn up a plethora of advice on what to do, where to put your money, what you should buy, sell, or hold. But what if you want to simply learn what the main components of the stock market are so that you can decide if this is something you should get involved with? Well, you have come to the right place.

We are going to present a basic primer about the stock market as a possible investing tool for you. You will learn what some of the terms mean and how they apply to you and your decisions. What we won’t be doing is – offering specific investment advice, selling you on some product that we make money on, trying to entice you to do something you don’t understand. This will be your plain language reference point about the stock market and how it works. We will be adding bite-sized pieces as you continue to build one piece of information upon the previous one until you have a fundamental understanding of how it works.

Let’s start with a basic explanation of what a stock market is. Most mature economic countries have at least one stock market that is regulated by the government that is charged with overseeing the operations to be sure they are open and transparent to its participants. At its most basic, a stock market is simply an auction site where people have the ability to buy and sell something, specifically, investment vehicles. Let’s use a story to illustrate how this works: suppose you have a neighbor named Bob (a coincidence – perhaps) who likes to tinker in his garage. Through his tinkering efforts and needs, Bob creates a very useful tool to help him. He continues to use and refine his tool until he gets it working absolutely perfectly – fantastic!

Now Bob, our erstwhile tinkerer, is also a pretty bright business guy and starts to think that if his invention is so valuable to him, it might also be valuable to other people. What would it take for him to make it available to a wide range of people? He would have to build some sort of manufacturing facility, buy raw materials, hire employees, create a marketing campaign, delivery processes, sales people, accountants, lawyers and on and on. All of this will cost a lot of money. Bob has some savings but would he be prepared to risk his family’s financial well-being by using his assets to start his company. Perhaps he could borrow money from the bank but they will want him to assign all of his assets to use as collateral for the loan – too risky. Is there an alternative?

Let’s present an approach that is used every day all over the world to allow Bob to start his company. We are going to ignore the regulatory, legal and accounting requirements of this exercise to keep it simple and it does not affect your ability to understand the functions of a stock exchange. Neighbor-Bob decides that he is willing to give up some ownership in his new enterprise in exchange for the money/capital to get it started. He decides that the company will have 1000 units of ownership (shares) and that he is willing to sell half of these to raise the capital needed. Let’s suppose he needs 5,000.00 to get it going so he will sell 500 shares through the stock exchange at 10.00 each. This means that other people will buy a total of 500 shares – or units of ownership.

We should give Bob’s company a name. Let’s call the company Orange. Here is what has just happened. “Orange” has used the facilities of a stock exchange to raise the capital it needs to start operations. Bob, its president, can now utilize the money raised to begin building the company. What happens to those people who purchased units of ownership or shares and how do they get rewarded? Coming up next will be a discussion of common shares, and how they change ownership and value.