AMFIE ACADEMY - investing in shares
Investing in Shares
By purchasing shares in a company, you acquire a title of ownership in the company’s equity and contribute to its long-term financing. Share ownership entitles you to receive information about the company’s performance and dividends if the company chooses to distribute them.
Shares are bought and sold over the counter or on the stock markets, where your shares will have a constantly changing price.
What are the advantages of investing in equities?
When you acquire shares, you become a part owner of a company and bare the associated risks, in proportion to the amount of equity you hold. However, while equities carry a higher level of risk than bonds, they have, historically, been more lucrative in the long-term. You can reduce your exposure to the risks associated with a particular company by diversifying your investments.
Investments in equities are remunerated in two ways:
Depending on the company’s performance, the general meeting of shareholders may vote to distribute a dividend. Sometimes companies decide to offer an optional dividend, which means that the shareholder can choose whether to receive it in cash or in the form of new shares.
The second form of remuneration is a capital gain, which occurs if the share sells for a higher amount than its purchase price. Conversely, you may also experience a capital loss. As long as you do not sell your shares any gain or loss will remain unrealized.
What determines share price?
The price of a share is determined by the level of supply and demand, which reflects the level of interest investors have in a share.
In the long-term, investor interest in a share is based on their perception of the quality of its fundamentals and of the related risks. A company’s fundamentals depend on numerous factors, such as its business model, technology, products and services, cost structure, financial health, strategic position, and growth outlook.
In the short-term, investor perception can be influenced by a great many factors, such as the company’s quarterly results. This can lead to significant price volatility (i.e. upward and downward price movements).
What are the different categories of equities?
Equities are categorized based on their propensity to pay dividends and their level of sensitivity to fluctuations in the market.
Defensive stocks are generally less sensitive to financial market fluctuations and are therefore more resilient when markets decline.
Cyclical stocks are more sensitive to changes in the economic environment and fluctuations in the market. This makes them riskier in the event of an economic downturn, but they can also be attractive when markets are expected to pick up.
Growth stocks are offered by companies that are considered to have a strong growth outlook. These companies distribute few or no dividends, as they prefer to reinvest their profits to finance growth. The value creation potential, which can lead to share price growth, makes them attractive to investors. However, the risk that this potential will not be met is often reflected in higher price fluctuations.
Value stocks are considered to be undervalued in light of their fundamentals. While they are generally more resilient when markets decline, they can prove risky in the long-term if their undervaluation is linked to declining business.
Finally, yield stocks are those issued by well-established companies with limited investment needs, which can afford to distribute high dividends on a regular basis. Yield stocks generally have a defensive profile.
What are the main risks associated with equity investments?
Capital risk: Shareholders own part of each company in which they are invested. If a company goes into liquidation, its shareholders risk losing their entire investment.
Market risk: The market price of a share can increase or decrease. Market trends and events specific to the company, which can occur separately or at once, place pressure on share price. When a share price falls below its purchase price, this creates an unrealized capital loss (if the share is sold the loss will become permanent).
Currency risk: Shares listed in foreign currencies will expose you to currency risk, relative to your reference currency. In other words, the valuation of the investment and the amount received when it is sold will depend, in part, on exchange rates.
Liquidity risk: Shares of certain companies, particularly those which are small or mid-cap offer lower liquidity. If trading volumes are not sufficient, an investor can be exposed to losses resulting from not being able to sell the shares under the desired pricing conditions.
Finally, in order to reduce your overall level of risk it is crucial to avoid concentrating your investments in a small number of companies, or a single sector or country, because their performance will be directly linked to changes in the markets in which they operate, as well as the risks specific to each of them. In other words, diversifying your portfolio across different markets and asset classes will have a substantial impact on lowering its overall level of risk.
This article is provided for educational purpose only and on the basis that you make your own investment decisions and do not rely upon it. AMFIE is not soliciting any action based on it and it does not constitute a personal recommendation or investment advice.
As part of AMFIE's cash management - Off Balance, the Association excludes all speculative products (Commodities, precious metals, options, convertible bonds). The categories of financial products in which AMFIE may invest are listed in Article 4 of the discretionary management mandate.