Here we are at session number 54 , and we’re going to be talking about investing in shares. This is going to be a kind of beginner’s guide, giving you the raw basics.

It won’t be exhaustive, because this is a big subject, but hopefully if you want to dabble in buying individual shares, you’ll know enough by the end to get started. By the end of this session though, you’ll know why I think direct investing in shares isn’t necessarily a good idea.

Click to Listen

Podcast: Subscribe in iTunes | Play in new window | Download

After the main body I’m NOT going to look at the most recent reviews that have been left by listeners, because there haven’t been any, but I AM going to answer a listener question that came in via email. I’ll announce the next session topic too. If this show is of any use to you, it would help me massively if you would take the time to leave me a review on iTunes. This has a huge impact on keeping me near the top of the rankings, which in turns helps more people to find the show and to subscribe. I’ll remind you again at the end of the show, but if you want to do it right now click the big button below:

But first…

Sponsor Message

This podcast is brought to you with the help of Seven Investment Management, a firm of investment managers based in London. They put their name to my show and to my site and videos because they believe in what I’m doing, and I’m very grateful for their support. You can see what they’re up to at 7im.co.uk

Introduction

Investing in shares is a subject requested by listener MW4224 who left me a review on iTunes (have I mentioned that?!) and asked if I could go into “more detail about share dealing including explanations of the terminology and mechanics behind why and how share prices fluctuate”. Well MW, your wish is my command, so let’s dive in and see what we shall see.

Everything you need to KNOW

As usual, let’s look first at what you need to know…

1 – A share is a tiny slice of a company

The clue is in the name, you see. You share the company with all the other shareholders. Your average listed company will be divided into tens or hundreds of millions of shares, so there are usually a lot of shareholders. What does ‘listed’ mean? Well, shares are bought and sold on stock markets, where traders and market-makers make deals between buyers and sellers and many millions if not billions of shares change hands every day.

So if you hold 200 shares in, say, Marks & Spencer, you are small fry in the grand scheme of things. But even though you are a tiny shareholder, you still have certain rights as a part-owner of that company. You get to vote on company resolutions, you will have some rights to capital should the company be wound up in the future, and you get a right to a dividend, which is a share-out of any profits made.

You can’t walk into M&S and start taking things off the shelves and walking out again without paying shouting “It’s my company…” All of the day to day decisions about how the company is run are devolved to the board of directors who are answerable to the shareholders. An Annual General Meeting or AGM is held, plus there may be other meetings throughout the year, where the board will report to shareholders about progress, or ask for a vote on certain items on the agenda, like approval of the accounts.

Most people don’t hold shares to have an influence on the running of the company though – you need a large shareholding to do that. Most hold them as an investment and are seeking either to see that investment grow over time, or to earn an income, or both.

If you are looking to make money out of share ownership you need to understand the mechanics of how their prices fluctuate.

Fundamentally, the laws of supply and demand are at work. Back in video episode 31 (Still one of my favourite episodes) I use the example of a stick, though I can’t remember why. I picked up a stick off the ground and waxed lyrical about what a lovely stick it was and how I thought it was worth £100. But no matter what I thought it was worth, if there was no buyer for the stick, it is essentially worthless. Conversely, if I met up with a stick collector, who really wants my stick to add to his collection, he may well be willing to part with the £100 and we’ve got a deal.

The principle is the same with property, with fruit and with pretty much anything which is bought and sold. There have to be two parties to a deal, a buyer and a seller, otherwise there IS no deal.

Now with listed shares, there are usually enough buyers and sellers to form a market, and this means that shares are quite liquid – they are easy to buy and sell. But the principles of supply and demand still apply.

Let’s say a company is led by a good board, is making a tidy profit and the outlook for the company and the sector it is in all looks good. Chances are there will be plenty of people wanting buy shares in that company. If there are more people looking to buy than there are looking to sell, the price will rise because supply is limited.

On the other hand if the company is poorly run and not making much if any profit, or is in a sector which is having a hard time for whatever reason, there may well be people looking to sell their shares in that company before things get too tough. This time, if there are more sellers than people wanting to buy, the price will go down because demand is limited.

It might not be just down to the performance of the particular company which affects share prices. It might be a healthy enough business, but if people start worrying about shares in general, they may sell their shares in that company, even though on the face of it that doesn’t make sense.

So micro factors like how a company is run as well as macro factors like the state of the wider economy and shareholder sentiment about markets in general all have a bearing on the price of shares.

As I mentioned before many shares pay a dividend. After all, there needs to be some benefits to share ownership other than hoping the price will go up, right? Well if a profit is made, and if the board decide that some of that profit should be shared out, then the board will declare a dividend. So let’s say a company makes £100 million profit after tax. And let’s say there are one million shares of the company. The board of the company might decide that of the £100 million profit, £80 million should be reinvested in opening new shops or upgrading machinery or bolstering reserves, but the ‘spare’ £20 million can be divided between the shareholders. Well, with one million shares in existence, each share would get £20. So if you hold 50 shares, you’d get £1000.

A history of paying decent dividends is another really important factor in the price of a share. A healthy income stream is always attractive to buyers.

2 – Terminology

Let’s look at some of the key terminology you might come across if you’re holding shares in listed companies.

Firstly some companies issue different kinds of shares. Usually, the main share class of any company are called ordinary shares. They will have a face value on them and sometimes this can look really strange, like 14  7/42ndths pence shares. This is the face value of the share, but has little bearing in the grand scheme of things. Once the shares are traded, the value of them is whatever the market says it is.

You can sometimes come across B shares which may have a right to a dividend but may not confer any voting rights on the holder. These often come up when companies merge.

You can also see things like zero-dividend preference shares, often just called zeros. As the name suggests, there is no right to any dividend here, so it is all about the share price.

Different classes of shares are issued to achieve different things for the company concerned. Most people hold the ordinary shares though, and it is these which are most widely traded.

The market cap – short for market capitalisation – of a company is basically the total value of all the issued shares in that company. The sum is simply the share price multiplied by the number of shares. So if a company has a million shares in circulation and the price of those shares is £1000 each, then the company has a market capitalisation of £1Billion.

You will here terms large large-, mid- or small-cap and these relate to the size of the company’s market cap relative to the general market. There are varying definitions of what large-cap means in monetary terms, but the most common suggestion I have found is that to be called large-cap, a company needs to be worth $10 billion or more. Mid-cap companies are usually said to be worth $1.5 billion to $10 billion and small cap anything from $1.5 billion down to $350 million. Smaller than that and you’re into the realm of micro-cap companies.

Companies of different market cap sizes are grouped together in indexes or indices. The FTSE 100 then, is the group of the 100 largest companies listed on the London stock exchange. The FTSE 250 is the next 250 companies. The FTSE 350 is the combination of the two – the top 350 listed companies by market cap.

A large cap company will often be paying a healthy dividend and is technically at least at lower risk of failure. Smaller companies are more likely to fail so the share price of small companies tends to fluctuate more than that of large companies

The earnings of a company are simply its profits. Take all the money it makes in sales, take of all the costs of the company and you’re left with the profits or earnings of the company. Of course, there are different ways of expressing this such as pre-tax and after-tax profits and earnings per share, which is simply the total profit divided by the number of shares in circulation.

Earnings are really important in determining share price though. Shares can be bought an sold on the expectation of a given level of earnings. If that expected level is exceeded or missed then it will have a direct impact on the share price. That’s why you hear about companies giving profit warnings – they are are letting the market know that they are likely to miss a target. OR when the actual results are announced, this lead to spikes or dips in the share price.

Finally the Price/Earnings Ratio or PE Ratio is a key metric which many investors get obsessed about. The figure is arrived at by dividing the share price by the earnings per share.

So if a share is priced at £50 and last year its earnings per share were £3.20, then its PE Ratio would be 15.625.

This measure is useful to compare one company with its peers in the same sector. So you could compare the PE ratios of all the housebuilding firms in the market for example. A high PE usually means that investors are expecting more growth in future. It is also possible to calculate the PE Ratio of an entire index of shares like the FTSE100 mentioned earlier.

3 – Risks of share investing

Investing in shares is either about making a quick buck or being in it for the longer term. If you buy a share thinking it will go up in value tomorrow, this is called day trading. Profits and losses tend to be small because most decent size companies don’t fluctuate in price quite that much, but they can do sometimes. Most people hold shares for the longer term. Either way you’re looking to the future to provide the returns you want, and it is impossible to predict the future. A share might took very healthy one minute, but all it takes is one bad piece of news and the price can plummet.

For example, a couple of weeks ago the Chancellor George Osborne announced sweeping changes to pensions in his budget. He delivered the news at about 12:45pm and by the end of the day less than four hours later, the share prices of two major annuity providers had dropped by 50%. No-one saw the Chancellor’s announcements coming. If you held those shares, you saw your investment halve in value in one afternoon.

No-one knows what’s around the corner.

It is possible for companies to fail in which case you may lose all of your money irrevocably. You might get something form the winding up of the company, but quite likely you won’t.

There’s always the danger you will pick the wrong stock. So perhaps you think that housebuilding is going to boom and you buy shares in Housebuilder A. But it turns out that the board of Housebuilder A are incompetent and the company fails, while Housebuilder B, which is very well-managed, rides the boom and its share price quadruples. You got the sector right, but the stock wrong.

The biggest risk is that you have no idea what you are doing. If you’re listening to this, chances are you’re a private investor looking to make better returns on shares than you can by keeping your money in the bank. Investing is part skill – knowing what to look for – and is much more about luck, in my opinion. A lucky amateur is a rare thing indeed.

4 – Hassles of share investing

There are various hassles which come with owning shares directly. It might just be me – I am always looking for an easy life – but I imagine you don’t particularly hanker for a complex life.

Being a shareholder means paperwork – a lot of it. If you’re the kind of person who can’t face paperwork and will just put it in a drawer and  not deal with it, then share ownership might not be for you. I have one client who inherited some shares from a deceased uncle who died back in 2001. Only now has he admitted defeat and got us to transfer the shares into his own name. The paperwork isn’t that strenuous when you know how, but for the amateur it can be terrifying .

You’ll get dividend vouchers which must be kept for tax purposes. You’ll get notices of AGMs and EGMs with all the resolutions laid out in usually a massive book of words.

Now and again a company you own will buy another firm or will itself be bought. Then you have all kinds of things to deal with, one of which is to keep track of the changing name of the company. I have had several clients over the years with four or more different share certificates with four different company names, only to discover that they are in fact the same company which has changed form several times.

Summarise KNOW

#1 – A share is a tiny slice of a company which confers certain rights. The value of that share depends on supply and demand fundamentally as well as other factors

#2 – You should know and understand the important terminology involved in share ownership

#3 – Holding shares comes with risks…

#4 – …and it comes with a shedload of paperwork.

So knowing all that, if I haven’t yet convinced you that owning shares directly isn’t a great idea, what should you do with that information?

Everything you need to DO 

1 – Pick your investing method

Maybe you like the idea of investing in shares but all the preceding info has made you question this. Well, as usual, there is more than one way to skin a cat.

The first thing is to decide whether or not to hold shares direct, like I’ve been describing above. The alternative is to hold them via a fund. Pretty much the last fifty sessions have talked about investing via funds so you can listen to almost any of them, but especially check out Session 41 on building gan investment portfolio, and Session 11 on platforms, wrappers and funds.

If you’re determined to stick with directly-held shares then you’ll either need to find a stockbroker or you’ll have to self-select.

A stockbroker can either work on an execution-only basis, which means he will just take your orders to buy and sell shares and place those orders in the market. He will charge you a custody fee for looking after the shares on their systems and dealing fees each time you buy and sell.

Alternatively a stockbroker can build a portfolio for you and will act as a portfolio manager, buying and selling the stocks he thinks will serve your goals on a discretionary basis, that is, he makes all the decisions.

Generally, using a stockbroker can be an expensive way to hold shares. The problem with dealing fees is that they are open ended. I fa stockbroker wants to earn more fees, he just has to buy and sell more stuff for you, whether that’s strictly necessary or not. I certainly don’t mean to tar all stockbrokers with the same brush, but you should definitely know what you are being charged. On several occasions we have spoken to clients with stockbroker portfolios who are convinced that they are only paying 1% per year. But when you turn to the transactions list on page 47 of their annual report, we have seen transaction fees add up to 4% of the portfolio value and more.

2 – If self-selecting, you’ll need a platform

A better way to hold direct shares these days is on an investment platform. There are many of these around, and they are improving all the time. I dealt with some of the major ones back in Session 37 so check that out for more detail.

These online systems allow you to place your own orders and log in to see how your portfolio is doing at any time. Most of them also have dealing fees but at least you are in charge and as the systems are all online, the deals can be quite cheap, especially if you are trading frequently.

Often the platforms will include news and wider economic data, plus research tools so you can narrow down the choice of shares you want to buy.

Be really careful of charges, which can be a minefield. I did some research for a client recently and there are lots of variables.  Good place to start in doing your research is my friends at The Platforum who have a page dedicated to helping you find a direct platform here.

3 – Don’t get emotionally attached to shares

Not so much a Do as a Don’t! I’m amazed how people can become emotionally attached to shares. I suppose I can sort of understand it if you hold shares in the company for whom you worked all your life. But some people inherit shares from deceased family members and develop an attachment to these even though they may be a terrible investment!

I had one client who worked for Cable and Wireless for 40 years, travelling the world as one of their engineers. He had well over £100,000 of shares in C&W when he retired, but a period of mismanagement saw his shareholding drop in value to just £8,000. He was advised for years to sell them to reduce his risk but he never would because he couldn’t believe that the company he worked for all that time could decline so far and so rapidly. Fortunately, he had other means…

I also have a friend who saw a six-figure holding in Lloyds Bank shares become worth just over ten thousand.

Remember the share markets don’t care about you. They are cold, unthinking capitalist machines, and they don’t care who they trample underfoot.

4 – Remember that shares represent only one asset class

There are several keys to successful investing, and one of the main ones is to hold your investment eggs in several different baskets. Shares are only one of many asset classes, all of which have things to add t your future wealth. Shares are certainly not the be-all and end-all but are rather just one choice among many. They are a major asset class, for sure, but don’t dismiss the others for all that.

A good place to start, though I say it myself, is Session 41 on building an investment portfolio. This gives you a good basis for getting started with investments, and explains the need for diversification and Asset Allocation as fundamentals for a successful portfolio.

Summary

I hope that gives you some idea of the world of share investing. I for one would avoid holding shares directly because it’s just a pain and I don’t know why you would do that when there are so many more painless ways to invest in this powerful asset class.

There’s a good page on the Money Advice Service website here for more of the same.

Listener Question – The Lone Crying Wolf

“I have been following your podcast work from near the beginning and I and many others have enjoyed and benefitted from your hard work and financial wisdom.  I was listening to your episode last week about the budget and as you know the Chancellor revealed some news about ISAs to take effect later this year.  With this in mind, I and many others may have the same or similar query that I'm hoping you would be kind enough to give a general steer.

At present I have both a cash ISA (with Virgin Money) and a Stocks and Shares ISA (with H/L) with both ISAs receive regular monthly investment amounts. I'm expecting a large payment from work mid April and would like to invest/shelter from tax somehow.  With the interest rate on the cash ISA due to drop to practically nothing at the end of the tax year and the new rules and allowances for the new ISA (NISA) not coming into effect until July, what should people in my position be looking to do that would not undermine their allowance position or cost a fortune in charges?  Any pointers you could give would be gratefully received.”

Good question Wolf! So you’d like to shelter the money you’re expecting from work when it comes and the logical place to do that is an ISA. I think the question is that as the ISA limit doesn’t go up to the £15k until July, what should you do with any money in excess of that in the meantime?

The first thing I would say is that if you’re likely to pay a lump sum and fully use your ISA allowance, I would stop your direct debits now. Once you have made one payment into your cash ISA and HL S&S ISA in the 14/15 tax year, you have set your stall out for the year. I would certainly stop the payment into the cash ISA if you want to shelter the full £15k into your S&S ISA.

The second thing I would say is that the ISA limit is a maximum contribution to an ISA, but not a maximum investment. I often have clients come to me say with £50k to invest. We’ll do their ISA and the balance goes into a GIA, or General Investment Account. It is invested in exactly the same way, just not inside an ISA wrapper. When the next tax year rolls around, we’ll shift the full allowance from the GIA into the ISA, and keep doing that every tax year until the whole amount is within the ISA. But the client doesn’t just send us the ISA money each year. They get their money invested from day one and progressively wrapped in an ISA over time. So don’t see the ISA limit as an investment limit.

I you’re married or in a serious, healthy relationship 😉 you can use our spouse’s allowance as well as your own.

Charges shouldn’t be astronomical if you’re on a self-select platform like HL either.

This week’s reviews

**None this week**

Tsk tsk.

If you like what you hear on this podcast, please leave a rating or review on iTunes by clicking the big red button below. This helps others to hear about the show and to subscribe, because it keeps me near the top of the rankings.

News

Yet another static week on the weight loss. This is starting to get a bit embarrassing. I feel like I’ve jinxed myself a bit like I have done before when I have announced on MeaningfulMoney that I’m going to do this and then haven’t managed to get very far. Pretty much the whole family has been poorly over the last three or four weeks so we’ve just kind of hunkered down and worked through it. I have a bunch of recipes for the 5:2 plan which I need to put into some kind of a program that I can stick to. I will keep you posted…

A record month in March for downloads of this show – just under 12,000 which is amazing. Thank you for your time each week.

Next Session Announcement

Next time we'll be talking about How to convince your partner to take an interest in the family finances. If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/feedback

Outro

That's it for this session of the MM podcast, I hope it was helpful. Did I miss anything? Do you have any questions? If so, please leave them in the comments section below

I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.