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: finaltigh@gmail.com
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