Why would you buy or not buy shares of a company without knowing much about its financial performance from its financial statements? There is always information on financial and or non-financial performance of any company that trade shares. You just have to look or ask for them.
Financial information and data on all companies? financial performance could be easily got from their financial statements. It is advisable to look for a number of financial statements (say, last three years, last five years, last ten years, etc) of companies that one wants to invest in. One does not necessary need to be a finance expert before one cannot understand financial matters. Everybody uses money, so everyone should be prepared to learn to become financially literate without necessarily becoming a financial expert. Financial literacy is not Finance neither is it Accounting. Financial literacy is everything about money that is not really taught in the normal classroom.
There is always so much information on any company that sells shares and where there is no enough financial and or non-financial information, one could always request for them.
Definition of a share:
The investopedia.com defines a share as ?a unit of ownership interest in a corporation or financial asset. While owning shares in a business does not mean that the shareholder has direct control over the business’s day-to-day operations, being a shareholder does entitle the possessor to an equal distribution in any profits, if any are declared in the form of dividends?
Types of shares:
Basically, there are two types of shares:
Preference shares or preferred stocks:
?Preference shares are differentiated from ordinary shares or common stocks by the way the dividend is paid. Preference shares dividends are paid based on a precise schedule. The shareholders are promised certain amounts of money on certain dates, and these amounts will be paid before ordinary shares, hence its “preference? status. However, preference shareholders cannot vote on any decisions related to corporate governance, and therefore have no say in any business decisions?
Ordinary shares or common stocks:
Ordinary or common shares as the name denotes, are common and are mostly the shares being traded on the various stock exchanges and or sold to investors from both public and private liability companies.
These types of shares bring along a number of benefits and rewards as well as risks. Ordinary or common shareholders are the same as equity shareholders who have voting rights though some of these common shares might have differential voting rights.
Ordinary shareholders or common stockholders have a share in the company?s profit after all legitimate deductions; including dividends of preference shareholders have been made. A share in a company?s profit is given to the shareholder in the form of dividends and ordinary shareholders get dividends as returns or rewards whenever they are declared by their company. These dividends are normally shared in proportion to the number of shares a shareholder has in the company.
Kinds of equity shares:
Rights Issue/ Rights Shares: ?This is the issue of new shares to existing shareholders at a ratio to those shares already held?
Bonus Shares: ?These are shares issued by companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the earlier years?
Returns to ordinary shareholders:
Capital Gain: This is a return or a reward to the shareholder when the price of the share increases. For instance, if one bought a share priced $2.00 and now the share price increases to $2.2, then there is an increase in value by two cents. It means one would get more money in return when one decides to sell one?s shares at $2.2 and make some gain. Capital gain is the same as capital appreciation.
Whenever the company?s share price increases, then the value of the share increases or appreciates automatically thereby creating more returns or rewards for the shareholder.
Dividend: This is a return or a reward to the shareholder from the company?s profit after payment of corporate tax by the company.
Holders of ordinary shares get returns or rewards in the form of dividends that is a share in the company?s profit after tax and all other legitimate deductions made. For instance, if a company makes a profit of $20,000.00 after tax, then the directors could decide they would share $10,000.00 to shareholders in the form of dividends. Each shareholder would get a part of this $10, 0000.00 according to the number of share one holds.
Earnings per Share 🙁 EPS) this is an indicator of a company?s profitability and should be calculated to get a fair idea of the company?s profitability relating to share earnings. This would help the prospective investor take an informed investment decision. EPS is a company’s net income expressed on a per share basis. Net income for a particular company can be found on its income statement or profit and loss account. ?It is important to note that the earnings per share formula? is used for only ordinary shares or common stocks and where there are preference shares or stocks their dividends there? are deducted from the net income before calculation is derived.
Earnings per share= Net Income ? (minus) dividend on preference shares/ (divided by) weighted average number of outstanding ordinary shares.
Dividend Per share (dps): This simply dividend the amount of declared by the number of shares. For, instance, you hold 2000 shares and your dividend declared to you is $2,000.00, the dividend per share would be:
Dividend/number of shares = dividend per share, therefore,
$2,000.00/2000= $1. 00 as dividend per share.
This calculation could also be done for the total number of shares the company has and the total amount declared as dividend. This would help you as prospective investor to decide whether you want to invest in that company or not after assessing the future returns on your investment in shares in a particular company.
Dividend Cover: This is the number of times a company?s yearly profit can pay its yearly declared dividend. It is calculated as profit after tax minus dividend paid on irredeemable preference shares divided by dividend paid to ordinary shareholders. Dividend Cover =Profit after-dividend paid to irredeemable preference shares/dividend paid to ordinary shareholders.
This would also help a prospective investor get advised by a company?s financial statements whether that company?s has the capacity to pay dividends for a short, medium or long time to come. This is should be done using many years? of a company?s financial statements as just one year or just few years would not necessarily give a true picture of future performance in terms of dividend payments.
Irredeemable preference shares are shares that would not be necessarily repaid by the company unless the company is winding up. The company might not offer to buy these shares back.
Many financially literate investors prefer to use cash related formulae to profit related formulae in calculating investment returns because cash is king and worthier and wealthier over profit. There many other preferred formulas for calculating dividend to shareholders such as the free cash flow to equity (fcfe) formula and others but the idea here is to create some awareness of how dividend calculations are done and also to encourage you to learn to calculate these figures as you can always pick the needed data from a company published financial statements. Everyone can learn to be financially literate. ?These pieces of financial information should help any prospective investor take informed decision.
Tax on Dividend and or Capital Gain:
Dividend and or capital gain are all types of portfolio income and for that matter are taxed in almost every country with various tax rates. In some countries, shareholders prefer to dividends to capital gains and in some countries some prefer capital gains to dividends because of the liability implications. It is advisable to know the tax rates and implications of either one or both in your country of residence, so you would be better informed to take a beneficial portfolio investment decision.
Shares (Equity Funding) as source of finance to companies:
Ordinary shares are issued by a company to people who want to become part owners of that company. Once, you buy some of the shares of a company, until you sell them, you are an automatic part owner of that company. This means you have given the company money in exchange of its shares, so the company has sourced finance from you and all other people who would buy some of the shares.
Entrepreneurs and business owners should aim at expanding their business and giving away some part ownership to investors that want to be part of their businesses. Businesses should therefore be run with the mindset that one day others would be needed to help with their money and ideas and expertise, so entrepreneurs should put into the right structures that would attract investors such as equity shareholders.
Benefits to the company selling ordinary shares or common stocks:
- Funds could be sourced from many prospective investors from across the globe.
- Long-term capital the company is not required to pay back in its life time and this could be permanent capital.
- Shares could be sold publicly to anybody or any institution interested in them or sold privately to private individuals or institutions that are interested in buying them.
- Dividend payments could be delayed till it is favourable for the company to start paying them out.
- Dividend is only paid if declared in a particular year, because dividends are declared subject to the availability of profit and cash to pay them out.
- Dividend amounts do not necessarily have to be increasing or decreasing yearly, they could be constant or increasing at an increasing rate or at a reducing rate. Management therefore has the leisure based on the company?s dividend policy to decide what to do when it comes to issues of dividend.
Companies that have sold their shares to equity shareholders or preparing to shares their shares to prospective investors need to be mindful that people invest because they need returns in the forms of dividends and or capital gains and for that matter management should try to make profits and have cash available to pay out dividends to shareholders or try make add more value to the share price so investors would mostly gain. It is disheartening to have shares of a company that does not pay out dividends and its share pricing is also falling. Inexperienced investors would lose much interest in the stock markets and this affects the general performance of a country?s or even the global stock market as many would or would not be interested in trading in shares.
Disadvantages to the company selling the equity shares:
- High issue costs, it costs very high to issues shares and the company might end up not meetings its target sales of the shares. The shares could be under subscribed by the public.
- Issue costs are not tax allowable expenses; most tax jurisdictions do not allow companies to deduct share issue costs from their revenue, so the companies have to bear these huge costs all by themselves.
- Excessive issue of equity shares to raise funds would end up making the few original shareholders poorer as they would have to share any small profit with many. The share price is likely to be diluted and original shareholders voting powers are diluted and reduced.
- Majority shareholders, these shareholders have more voting powers and control and could try to manipulate management to take certain decisions that might not be in the interest of other shareholders? and other stakeholders though all shareholders and stakeholders? interests are also important.
- Speculations on the stock market, equity shares of good performing companies are hotcakes on the markets and speculations about their values are not good for the company as the price keeps moving up and down.
Benefits to the investor of ordinary shares or common stocks:
- Both Cash flow and capital gain are possible for the investor, where a company pays out dividend yearly and its share price is also increasing, then the equity shareholders enjoys both cash flow as dividend and capital gain as the share price appreciates.
- High returns in boom periods of the markets, equity shareholders could get very high returns on their investments compared to others as they are the last to benefit from good performance.
- Right to participant in the management if the company, equity shareholders have voting rights in electing and removing directors and auditors and some shareholders with needed expertise could even be involved with the daily activities of the company to help it succeed greatly.
- Shares could be acquired with small capital; anybody interested in being equity needs just small capital to buy the minimum numbers of shares to become a part owner.
Disadvantages to the investor:
- Loss of everything on liquidation of the company, where the company winds up or liquidates, closes down permanently, equity shareholders lose all their investment, unless the winding up or closing down is profitable after paying all others including preference shareholders. This type of investment has no insurance that is why it is called ordinary share or common stock.
- Irregular passive income, dividends to be received would not be constant in terms of yearly increment and even some cases there would be no dividends. Decisions on dividends are taken by the board of directors subject to the availability of profits and the intended use of profits by the company.
- Initial capital could reduce where the share price keeps moving down, the investor losses if he decides to sell and where they decide to hold and pray for an increase in share value, it is still not predictable the price would increase.
- No control over one?s money, individual small equity shareholders do not have many shares and for that matter do not have much say and cannot control or manipulate management for their interests. Where is no control over one?s money, one cannot really determine where one?s money goes.
Where to trade shares:
Shares of public listed companies are traded on various stock exchanges all over the world. In many countries there are also stock exchanges for small and medium enterprises that do not qualify to be listed on the main exchanges to also raise funds from those markets.
In Ghana, one has recently been set up but its publicity is not there for intended companies to take advantage of its existence.
Here is a good article on Ghana Alternative Market (GAX) from a good friend of mine, Sophia Teye Kafui, an investment banker. It would help educate you a lot on it. (http://skafuiteye.blogspot.com/2013/07/have-you-considered-ghana-alternative.html)
Other countries also have theirs, for instance, in the UK they have the Alternative Investment Market (AIM)
These markets are there for small and medium enterprises to trade their shares to raise the needed funds for expansion and other purposes.
Entrepreneurs everywhere need to know the existence of these markets to try to meet their requirements to be able to take advantage of their services.
The Inside Investor
This is an investor, who starts a business and probably owns all or majority of the shares of that business and mostly they are key part of the management of the company. Therefore, they know everything inside out about the company. This is the original owner of the company and could later sell part of his/her shares to others, while he/she still remains in management of the company.
The Ultimate Investor
This is an investor, who has been able to run his/her successfully and is now selling some of his shares to the public to raise funds for many purposes. The ultimate investor is a selling shareholder and the outside investor buying is a buying shareholder.
Most of the people that buy shares would not be part of the management of the company would be outside shareholders or investors. They would be sleeping in the houses and expecting the ultimate investor to turnaround their money for them to get their dividends. What they need is just a good return on their money and they do not care much about what is going in the boardroom of the company. The ultimate investor takes most decisions, good or bad for the outside investor.
Shareholders and management
In many big businesses, the shareholders are mostly not the same as the board of directors or management running the affairs of the company. Shareholders are the owners of the company while the members of management are mostly employees, who do not necessarily have some shares and for that matter are not part owners of the company. Shareholders have their own interests that should be line with the interests of management but this is not always the case. Shareholders would mostly be looking for long-term success of the company while management wants to succeed in the short-term to be commended and given rewards.
There is always conflict of interest between what shareholders want done and what management wants to do, but the interests of shareholders should be paramount over management interests. Shareholders should always try to monitor management to take decisions that are in the best interest of shareholders and all other stakeholders, including management and employees.
Performance linked to profitability and reward schemes and incentives should not be introduced in such a way that management could manipulate them to satisfy their short-term individualistic aims.
Patience is needed in every investment and all entrepreneurs and investors should learn to be emotionally intelligent.
Warrant Buffet wrote ?The stock market dominates the investment market for a period of twenty years. As the twentieth year approaches, the possibility of a market crash increases. After the crash, the stock market tends to stay down for ten years. During the ten years the stock market is down, commodities such as gold, silver, oil and property dominate the investment world. And every five years, there is some kind of major disaster.?
I believe anybody following investment markets in the world would agree with the richest portfolio income earner, Warren Buffet.
We should not forget that no condition is permanent and so anything instituted by man would not last forever without crumbling down. There would be times investments in all sectors would boom and times that they would crumble down.
Robert Kiyosaki also wrote ?Invest for cash flow and you?ll never worry about money. Invest for cash flow, and you will not be wiped out in boom and bust markets. Invest for cash flow and you?ll be a rich man?
Godwin-Xavier Ayeebo is a Financial Literacy Activist, an Accountant, a Writer and Founder of Financial Literacy Training Institute, (FINALTI) incorporated and registered under the laws of Ghana to help educate the Ghanaian and the world populace on Financial Literacy.
?2013, Godwin-Xavier Ayeebo
Email:? [email protected]