How can I make money investing in shares?

In the past, investing directly in shares was something only for investors who could afford the large minimum amounts required by stockbrokers to open an investment account.

But the share trading capabilities offered by online stockbrokers and financial service providers (FSPs) have democratised the share market, and today anyone with a smartphone and a couple of hundred rands to spare can invest.

Before you invest, it is worthwhile getting a basic understanding of how the share market works.

What is a share?

A share is a unit of ownership in a company. “Share” is the English term, “stock” the American term, while “equities” refers to the asset class as a whole.

If you buy shares in a company, you become a part-owner of the company, or shareholder, and this gives you certain rights. These are typically the right to a portion of the company’s profits in the form of dividends and the right to a say in decisions affecting the company by voting on issues at shareholder meetings.

All companies have shareholders, but only public companies – those listed on a public stock exchange such as the JSE – offer shares that are openly available to anyone who wants to buy them. This article focuses on investing in listed, public companies, as opposed to private companies, which are not listed on an exchange and are owned by a closed group of shareholders. 

The stock exchange as a market

Issuing shares is a way companies can raise money for expansion. This is done through a public offering, when a block of shares becomes available on a stock exchange at a certain price per share.

Once the shares have entered the market, investors can buy and sell them at will, and the price of the share will fluctuate: if there are more sellers than buyers, the share price will drop; if there are more buyers than sellers, it will rise.

For example, a company raises capital of R10 million by issuing a million shares at R10 each. Once in circulation, the shares may trade below or above the initial R10, depending on the supply and demand from investors.

Types of shares

There are different types of shares, each with different rights for shareholders. These differ from company to company, but can generally be classified as follows:

1.  Ordinary shares. These comprise the bulk of shares traded on the open market. They pay regular dividends - although these are not guaranteed as the company may not always be in a position to pay them - and grant the holder the right to vote at the company’s annual general meeting (AGM).

2.  Preference shares. These give the holder certain preferential rights regarding the payment of dividends (dividends may be guaranteed at a fixed amount annually) and higher priority among creditors if the company is liquidated. However, preference shareholders do not typically have voting rights.

Preference shares are similar to fixed interest investments, such as bonds, in that they offer more stable returns than ordinary shares.

How do you make money from shares?

There are two sources of returns from share investments: 

1.  Capital gain

You make a gain when the share price rises above the price at which you bought it.

2.  Dividends

These payments are what the company distributes from its profits to its shareholders, usually annually or bi-annually. Some companies, especially younger ones, don’t pay dividends because they use their profits to fund growth and pay off debts. You can either receive your dividends as cash or reinvest them to boost your investment growth.

A share’s dividend yield is the annual dividend per share as a percentage of the share price. If the share price rises, the dividend yield drops, and vice versa. For example, if a company’s share price is R20 and it pays a dividend of R1 per share, the dividend yield is 5%. However, if it maintains its dividend of R1 per share when its share price plummets to R10, the dividend yield shoots up to 10%.

What are the risks of investing in shares?

The main risks that come with investing in shares are:

• Volatility
  Share prices can go up or down, often seemingly irrationally. Many factors influence a share’s price. They range from company-specific factors, such as how the business is run, to external factors, such as a weakening economy. All these factors influence investors’ views – known as the market sentiment.
  
  
• Dividend suspension 
  One reason for a dividend suspension would be when a company is in financial difficulty and decides to suspend dividend distributions until conditions improve.
  
  
• Company failure
  Companies can go out of business, in which case ordinary shareholders are among the last to receive any compensation from a liquidation of assets.
  
  
• Share suspension 
  In certain circumstances, the stock exchange may, to protect shareholders, suspend trading in a company’s share for a period or indefinitely.

Mitigating the risks

Most investment experts agree that equities offer the best returns against inflation. But this comes through taking measures to offset the risks:

• Choose wisely
  Research a company before you invest in it, as you would when buying a car or sound system. What are its strengths and weaknesses? How is it positioned for the future?
  
  Alternatively use the services of a stockbroker who will do the research for you, bearing in mind that you will pay for this expert advice.

• Think long term 
  Price volatility smooths out over the long term. If you try to time share movements over the short term, you speculate, a high-risk activity that should not be confused with long-term investing.

• Diversify 
  Spread your investments across a variety of companies to avoid what is known as concentration risk – the financial term for putting all your eggs in one basket. Read more: Why should I diversify my investments?

How can I invest in shares?

You can invest directly, through a stockbroker or online stockbroking app or platform, or indirectly, through unit trusts or exchange traded funds (ETFs) that invest in equities.

The advantage of investing through unit trusts or ETFs is that share selection and diversification is done for you. In a unit trust fund you harness the expertise of the fund manager, while an ETF, which is bought and sold like a share on the exchange, offers you a basket of shares represented by the composition of an index. Read more: What is a unit trust fund? and What is an exchange traded fund (ETF)?

When you invest directly in shares, the easiest way is via an online platform offered by a stockbroker or an FSP. FSPs, such as major banks, have their own platforms, and there are also some popular non-bank platforms to choose from. Minimum-investment thresholds are generally low (for example, R5 or R250), but the platforms’ costs, which include monthly fees and transaction fees, vary.