How it works
A company divides its ownership into a fixed number of shares. Someone who holds 50 of 1,000 shares owns one twentieth of the company. That fraction is what matters, not the number of shares: 50 shares of 1,000 is a larger stake than 500 of a million.
When the company makes a profit, the profit belongs to the shareholders, but it does not arrive automatically. The directors decide how much to pay out and how much to keep in the business. The part paid out is the dividend, and it is the same amount for every share. The part kept may make the company more valuable, or may not.
Shares of a listed company change hands on a stock exchange. The price is whatever buyers and sellers agree on at that moment, and it reflects what they expect the company to earn in future as much as what it earns now. A shareholder’s return comes from two places: dividends received, and the difference between the price paid and the price later sold at.
Shareholders usually have a vote at the company’s meetings in proportion to their shares, and their loss is limited to what they paid: if the company fails, its creditors cannot pursue the shareholders for more.
What it costs
- A dealing charge or commission each time shares are bought or sold.
- The spread: the gap between the price to buy and the price to sell at the same moment.
- A platform or custody charge for holding the shares, in many accounts.
- Taxes, which differ by country: some charge a tax on purchases, most tax dividends or gains in some way.
- A currency conversion charge when the shares are priced in another currency.
The risks
- The price can fall a long way and stay there. Nothing obliges it to return to what was paid.
- A single company can fail. Shareholders are paid last, after lenders and other creditors, and often receive nothing.
- A dividend is a decision, not a debt. It can be reduced or stopped at any time.
- A few shares in a few companies is a concentrated holding: one piece of bad news can remove a large part of it.
- Shares priced in another currency rise and fall with that currency as well.
Where people go wrong
- Calling a share “cheap” because its price is a small number. The price of one share says nothing without the number of shares in issue.
- Reading a high dividend as a safe one. A dividend that is large compared with the share price is often large because the price has fallen, and may be about to be cut.
- Treating a familiar company as a sound investment. Knowing a firm’s products is not knowing its accounts.
- Judging a holding by the price paid. The market does not know or care what anyone paid.
- Checking the price many times a day and acting on each move. Costs are certain; the benefit of frequent dealing is not.
Questions people ask
- What is the difference between a stock and a share?
- In everyday use, none. “Shares” usually means the units of one company, and “stocks” is the broader word for shares in general. “Equities” means the same again.
- Is a dividend guaranteed?
- No. The directors of a company decide each time whether to pay a dividend and how much. A company may pay none, and a company that has paid one for years may reduce or stop it.
- Can a shareholder lose more than they paid for the shares?
- Not when the shares are bought outright with the holder’s own money: the most that can be lost is the amount paid. Buying with borrowed money, or through a leveraged product, is a different matter and can lose more.
The words on this page
A general explanation for study, with invented examples. Costs, taxes and rules differ by country, market and product, and the documents of the thing itself are what count. Educational information, not investment advice or a recommendation to trade.