Shares represent your part ownership (or share) in a business.
Companies can raise money to finance their business by 'going public'. Going public means being listed on a stock exchange and issuing shares to investors.
By paying for the shares, each investor buys part ownership of the company's business and becomes a shareholder in the company.
The money that a company raises in this way is called equity capital. Unlike debt capital which is borrowed money, equity capital does not need to be repaid as it represents continuous ownership of the company.
In return for investing in the company, shareholders can receive dividends and other benefits. A dividend is the distribution of a company's net profit to shareholders.
Shares that have been issued to investors by a listed company can be sold to other investors on the sharemarket. You make a profit when you sell your shares for more than you paid for them.
Buying and selling shares
Your adviser can buy and sell existing shares on your instruction on any business day on one of the recognised Australian securities exchanges (ASX or Cboe).
Orders to buy and sell shares are entered into a computerised trading system by your broking firm (e.g. Morgans). Buy and sell orders are matched by price in the order they were entered into the system.
That way, every order is processed by price and on a first in, first served basis. Larger orders do not have any priority. A trade occurs whenever a buy order is matched with a sell order.
Trades are settled on the second business day after the trade takes place. This means ownership of the shares and related payments between the buyer's broker and the seller's broker are transferred on that day.
All Australian listed shares are registered electronically on either the Clearing House Electronic Sub-register System (CHESS) operated by a subsidiary of the ASX Group, on behalf of listed companies, or on the companies' own sub-registers.
New shares
Alternatively, you can buy new shares that are issued by companies from time to time by applying to participate in a float or initial public offering (IPO). Shares you buy through an IPO are registered as Issuer Sponsored Holdings. The price of shares issued in a float is generally specified in the prospectus.
If you wish to buy shares in the float, you should first review the prospectus then fill out the attached application form specifying the number of shares you wish to buy and lodge it with your adviser before the application deadline.
Once new shares are issued and listed on a recognised Australian securities exchange, they may trade at a market price substantially different from the issue price (either higher or lower). This is due to supply and demand for the shares in the company.
Share performance
Sharemarket indices represent the overall performance of companies listed on a stock exchange. Investors can use these indices to track how an investment is performing by watching its share price.
The key sharemarket indices in Australia are the Standard & Poor's (S&P)/Australian Securities Exchange (ASX) indices.
These include the All Ordinaries Index (All Ords), which is a market capitalisation index comprising the 500 largest companies listed on the Australian Stock Exchange, and segments of the ASX, called:
- S&P/ASX20 – Top 20 stocks
- S&P/ASX50 – Top 50 stocks
- S&P/ASX100 – Top 100 stocks
- S&P/ASX200 – Top 200 stocks
- S&P/ASX300 – Top 300 stocks
Another way to track your shares' performance is to calculate the dividend yield from your portfolio on an annual or more regular basis. This can be a more reliable measure because share prices rise and fall on a daily basis, whereas dividend income is usually much steadier and often grows over time.
Risk and benefits
Capital growth
As a longterm investment, shares have the potential to provide better returns after tax than any other major investment. However, past performance is no guarantee of future returns.
Although share values have risen over the long-term, this has been punctuated with periods of short-term volatility, where prices can go up or down very quickly. For this reason, it is usually important to adopt a medium to longterm investment view of five years or more.
Dividend income
Another benefit of being a shareholder is dividend income, although dividend yields vary greatly from company to company.
Companies trying to grow their business might provide a low dividend yield (perhaps 2-4%) while other, more established companies might provide a higher dividend yield (potentially between 6-8%).
Tax benefits
Shareholders have to pay Capital Gains Tax on any net capital gains made by selling shares; however, their income tax liability can be offset through dividends they receive with franking credits.
Franking credits pass on the value of any tax that a company has already paid on its profits. A company can pay a fully franked dividend if it has paid full corporate tax on the profits distributed as dividends. A partly franked dividend would be paid if the balance of the franking account was not sufficient to pay a fully franked dividend. An unfranked dividend is declared where there is nothing in the franking account.
A company will advise shareholders of the status of the dividend at the time of payment. If you receive franked dividends, you must declare both the cash amount and any franking credits as assessable income in your tax return. Then you can apply the franking credit amount to reduce your income tax liability.
Risks
Share prices of any company, even a blue chip, are always subject to change. Some investors fall into the trap of putting all their money into one asset class – usually at its peak, and then watch as another asset class takes off without them. It is important to have a number of different shares in your portfolio to reduce the risk inherent in share investing.
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