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Stock basicsLevel 2Products8 minUpdated What is a share and what do you own?
A share is not a price chart or a lottery ticket. It is an ownership stake in a real company, and that ownership comes with certain rights and certain limits.
- What an ownership stake means in practice
- Which rights a share gives you, and which it doesn't
- Why a share's price alone tells you nothing
- What market cap tells you about a company's size
You own part of a company
When a company needs money to grow, it can divide its ownership into parts and sell them. These parts are shares. If a company has 100 million shares and you own a hundred of them, you own one millionth of the company.
That is the whole idea. Everything else (share prices, key figures, earnings seasons) is a way of assessing what that one millionth is worth and what it produces.
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What rights does ownership give you?
What you don't own
You don't own the company's assets directly. You can't walk into the factory and take away a machine that matches your stake. Nor do you decide on the company's day-to-day running. Management does that, under the supervision of the board.
The company
- Profit for the year
- €50,000
- Total shares
- 100
- Profit per share
- €500
Your stake
- You own
- 10 shares
- Your stake in the company
- 10%
- Your share of the profit
- €5,000
Note: your share of the profit doesn't mean you get €5,000 in your account. The general meeting decides how much of the profit is paid out as dividends and how much stays in the company to grow its value.
Your liability is limited to the amount you invested
A key feature of a limited company is limited liability. If the company goes bankrupt, you lose the money you invested, but you don't have to answer personally for the company's debts.
A key feature of a limited company is limited liability. If the company goes bankrupt, you lose the money you invested, but you don't have to answer personally for the company's debts.
In a bankruptcy, the shareholder is last in line. Creditors are paid first, and only if something is left over is it distributed to the owners. In practice, there is usually nothing left for shareholders. This is the price of the shareholder also getting all of the upside.
- Secured creditorsBanks and lenders whose claims are backed by collateral.
- Unsecured creditorsSuppliers, bondholders and others who have invoiced the company.
- ShareholdersGet whatever is left after the creditors. In practice, often nothing.
This is why a stock's expected return is higher than a bond's. You take on more risk because you are last in line, and in return you also get all of the upside if the company succeeds.
The price depends on how many parts the company is divided into
Imagine two companies of exactly the same value, both worth €1,000 million. The first is divided into 100 million shares, so a share costs €10. The second is divided into about 3.33 million shares, so a share costs €300.
The companies are equally valuable. Only the divisor is different. This is why comparing share prices between two companies is meaningless.
Company A
- Share price
- €10
- Shares
- 100 million
- Market cap
- €1,000 million
- Earnings for the year
- €80 million
Company B
- Share price
- €300
- Shares
- 3.33 million
- Market cap
- €1,000 million
- Earnings for the year
- €80 million
The only difference is how many parts the company is divided into. If you want to know whether a stock is expensive, compare the market cap to the earnings. Don't look at the share price in euros.
Market cap is the real measure of size
Market cap = share price × number of shares. It tells you what the market values the whole company at.
This is the figure worth looking at instead of the price. It makes companies comparable and also tells you something about the nature of the company.
This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns.
Where does a shareholder's return come from?
When you own part of a company, your holding can produce a return in two ways. The company can pay part of its profit to its owners as a dividend: that is money moving from the company to your account. Or the company can keep the profit and invest it in growth, in which case the value of the business rises and the value of the share rises with it. In both cases the source is the same: the company's ability to make a profit.
Here is the most important insight of this lesson. A stock's return doesn't come from someone paying more for it tomorrow. That is only a price change. The return comes from the business you own creating value and either distributing it or growing it. Over the long term the price follows this, but in the short term it lives a life of its own.
In the next lesson, we take both parts apart and look at how together they make up the total return.
What does this mean for an investor?
When you buy a share, you are in practice making one decision: do you want to be a part-owner of this company. That is a different question from “will this share price go up”.
- A share's value is based on what the company produces in the future, not on what the share price did last week.
- A company's success and the stock's return correlate over the long term, but they can diverge in the short term.
- Because liability is limited, the most you can lose is the amount you invested, but you can lose all of it.
This content is for information purposes only and should not be construed as investment advice or a recommendation. Investing always involves the risk of losing capital. The value of financial instruments and investments can go up or down, and past performance is no guarantee of future returns.
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