Saturday, February 10, 2007

Some basics

Finally I have gotten round to doing it! I will make it look like a Q&A session...anything you don't understand.....ask!!! Am sure you guys know most of this stuff but I will start with the basics anyway.....more like a revision session, no?

What is a share?

A share is a unit of ownership in a corporation or a financial asset. This does not however give the holder of the shares direct control of the company's daily operations.

Companies issue shares because they want to raise money for one reason or the other; say to expand their operations or buy new machinery. They could very well get this money by borrowing from a bank but this would be costly to them as they would have to pay interest on the money as well as pay the money back. So the cheapest option……issue shares or rather sell a part of the company to the public. This is money that they will never have to pay back..... and, there is no interest to be paid later.

Shareholders buy these shares on the premise that the price will rise to a level higher than what they paid for them, they will sell them and make a profit. There is also the lure of dividends especially when a company makes good profits although, a company is under no obligation to pay out all or any if its profits as dividends.

The two main types of shares are common shares (ordinary shares i.e. what is traded on the NSE, LSE, NYSE etc) and preferential shares (debt to the company).

Ordinary shares represent ownership of the company but it does not give you the right to run it on a day to day basis. You do have one vote though which you can use to elect the board members who will run the company for you. Ordinary shares also entitle you to partake in the company’s profits in the form of dividends although as stated earlier, the company is under no obligation to pay out dividends. Unfortunately , even though this class offers the highest returns, is also the riskiest; in case the company goes bankrupt, you will not be paid anything until all the creditors, bond holders and preferential shareholders have been paid ( high risk, high return)
Preferential shares also represent ownership of the company but they differ with ordinary shares in terms of voting rights; depending on the company, they have no voting rights. Also, they are paid a fixed dividend (more like interest) which is guaranteed i.e. even if the company has not made a profit, these guys have to be paid! Another advantage of this share class is that if the company were to go into liquidation, they would be paid before the ordinary shareholders.

What is a stock market?

A market like any other only that people “meet” to buy financial securities (stocks, bonds etc). There are two types of markets (although there is no physical distinction really): a primary market and a secondary market.

A primary market is where new securities are created through an Initial Public Offering (IPO). A secondary market is where investors trade previously issued securities i.e. after an IPO the shares start being traded…this is the secondary market and it is what we talk about when we refer to the stock market.

We’ve all heard of the terms a “bull” market or a “bear” market being used to describe the stock market. These are terms that are used to describe stock market trends. A bull market can be described as a period when prices at the stock market are rising rapidly. A bear market is the opposite of this i.e. when prices at the stock market are declining rapidly. Bull markets are characterised by increasing investor confidence, investors buy in anticipation of further capital gains.

What is an Index?
A stock market index can be described as a figure that is used to measure the state of the stock market. It is based on the performance of a group of stocks which are chosen by the stock exchange body and which meet some set criteria, for example they trade in the same stock market, they have similar market capitalisation or they belong to the same industry. Indices are used to benchmark the performance of portfolios.
There are different ways of calculating an index each of which has its merits and demerits. The NSE 20 share index is the official index used at the Nairobi Stock Exchange. As the name suggests, it comprises of 20 key stocks ( which elude me just now but I will remember them in due course). The NSE 20 is a price weighted index i.e. its value is influenced by the prices of its constituent stocks. Thus, stocks with a higher price will be given more weight and, they will have a greater influence over the performance of the index. For example, say Jubilee Insurance ( price Ksh 303 as at Wed 7th Feb source: and Kenya Orchards ( price Ksh 5 as at Wed 7th Feb source: are both constituents of the index. Jubilee will have a higher weighting than Kenya Orchards due to its price and thus a movement in Jubilee share will cause a larger movement in the index than a movement in Kenya Orchards would.

1 comment:

MainaT said...

God is good! Ati you finally posted.
Anyway, it looks good. Can you tell us something about stock spilts, bonus share issues, dividends, ex-cum and the like?