What are shares?

What are shares? Why should I own shares?

What is a share?

A share is a fractional part of the ownership of a company or some other type of financial asset, and entitlement to part of its profits.

The dictionary definition of a share is

“one of the equal parts into which a company’s capital is divided, entitling the holder to a proportion of the profits.”

A large company is usually owned by more than one person. The ownership is split between all the shareholders (the owners of the shares in that company) according to the number of shares they own. 

A simple example would be, if company ABC has 1000 shares in existence, and you owned 10 of them, you would own 1% of the company (10/1000 = 0.01 or 1%).

Typically, companies issue millions of shares, in order to make each one an accessible price for retail investors. A giant company like Apple has about 4.6 billion of them in existence at the last count. The ownership of that company has been divided into 4.6 billion pieces, and if you bought 1 share, you would own 0.000000000217% of the company.

If you bought 5 shares (at the time of writing this, each share is worth $182), you would own a 1 billionth (0.000000001%) of Apple.

Are stocks the best way to build wealth?

Stocks and shares over the last hundred years or so have been the single most effective way of building wealth. They have beaten all other asset classes like property, gold, bonds or commodities hands down. It is never a smooth path, and there are many ups and downs along the way, but over a long enough time frame, owning a collection of shares is the best way to build wealth.

Capitalism may not be your cup of tea, and admittedly that there are many examples in the world of capitalism done badly, but you could say the same for all other ideologies. I’m not here to discuss the merits of it, but all I’ll say is like it or loathe it, it is undeniably effective.

The Dow Jones Industrial Index or DJIA (an index of the shares of large American companies) was founded in 1896 (with 12 companies, which later grew to 30). It had a starting value of 40.94. At the time of writing it is trading at 28,635.06. That is a growth of about 700x or about 5.4% annually.

$100 invested in the DJIA in 1896 would have now grown to a sum of about $70,000 at the end of 2019 before any dividends have been reinvested. With dividends reinvested (see below for what this means), this would have become a staggering $15,000,000! That is made up of a compound growth rate of 10.1% – almost double the rate without the dividends reinvested. (DJIA returns calculator can be found here if you want to check these numbers.)

(These figures exclude costs of trading and taxes, but they give you a good idea of the power of owning shares.)

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Why should I own shares?

By owning shares in a company, you are taking ownership of a slice of it. That company is a very real entity whose reason for existence is to make a profit.

Shares may just look like numbers on a screen, but they are much more than that. If you own shares in a company, you actually have people working for you now. The employees of that company are working day in and day out, to try and make money. Some of that money will be used for the running of the company, some will be used to grow the company, and eventually, some of the profits will be split between the owners. The owners of the company are the shareholders. That’s you.

If you are a shareholder in a company, not only are you a part-owner of the company, you are entitled to part of its profits when it pays them out. The board of directors will decide how much they are paying out, and then pay those profits in the form of dividends. They are usually paid out once or twice a year. 

Not only will you profit from the dividends that are paid out by companies, but you may also profit from the growth in their share prices. This can happen for many reasons, but fundamentally the price of a share reflects what people think the prospects are for that company. If they think the company is becoming more profitable over time, they will be willing to pay more for the shares, bidding the price higher.

The assets that a company owns and the profits it can make on its goods and services are also linked to inflation. As inflation creeps higher, so do profits and share prices over time. Owning shares is pretty much the best way to protect you from the long term wealth-depleting effects of inflation. 

(If you want a detailed look at how best to protect against inflation and other threats to your wealth, rather than just the answer, the best resource I know of is Dr. William Bernstein in his book – Deep Risk.)

What is dividend reinvestment?

Dividend reinvestment means using the dividends paid out from owning shares, to simply purchase more shares with the money received. This reinvests your profits for further growth. The alternative is to keep the dividends as cash and use them for day-to-day spending which may be more appropriate for someone in retirement who is not in a wealth-building phase of life.

Are shares the same as stocks?

Basically yes, they are almost the same, but when people refer to owning shares, they are usually talking about owning shares in one particular company. If they refer to stocks, they are likely to be referring to shares in more than one company.

More details on the difference between stocks and shares, right here.

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