Shares Definition:- The equity papers that represent ownership of company are referred to as stocks/shares. The holder of stocks/shares of particular company is regarded as the part owner of that company. The stock/shares are direct claim securities whose value is associated with some underlying real asset. When a company needs to raise money it can issue stocks/shares to the general public.
Every stock/share has fix face value which is written on it. When a person (or company) buys that piece of stock/share, he becomes owner of that company up-to the value of his stock/share and he will receive profit (dividend) from the company. In this way the company raises money by issuing its shares and the shareholders will participate in the profit & loss of the company. Besides par value, stocks/shares also have market value which fluctuates on the basis of perception of investors and the demand & supply of the shares in the market. The shares are separate from bonds because bonds are debt instruments while shares represent ownership.
Advantage of Raising Capital through Stocks/Shares
The company that raises capital through equity has certain advantages. One advantage is that the company is not bound to pay regular interest payments to its shareholders. The company may pay dividend to its shareholders according to the decision of the board of directors or management.
- Position on Balance Sheet:
The company issuing stocks/shares is actually raising capital through equity so the issuing stocks/shares become liability for it and is shown on the liability side of the balance sheet under the head of capital. On the other hand if a company invests into shares of another company than those shares are shown at the asset side of the balance sheet of the investing company under the head of marketable securities.
- Cash Flows of Stocks/Shares
Shares are linked with the real assets of company which generate certain cash flows over a period of time. The value of stock/share is derived from the cash flows generated by some real assets of the company. Following are the two cash flows that are associated with the stock/share.
- Dividend received by shareholder
- Capital Gain
For example if a there is a textile company that needs cash of Rs 200,000 for purchasing new looms and it raises that cash by issuing stocks/shares of Rs 200,000 and sell them to different investors. Each stock/share has fix face value. Two types of cash flows are generated from the investment made by the shareholders. One type of cash flow takes the form of income while other takes form of capital gains. In this example the real assets include textile weaving looms & fabric manufactured by these looms. The sale of fabric generates cash flows and the dividend paid to shareholders comes from these cash flows.
- The Concept of Stock/Share:
When a limited company decides to raise money through equity, it issues stocks/shares. The face value or par value of each share issued by public limited companies in Pakistan is generally Rs 10. The stock/share has fix par value and when it comes in the market it contains separate market value which is different from the fixed par value. The share has infinite or perpetual life unless the company makes decision to close down or become bankrupt.
With the passage of time the financial health of the company fluctuates which changes the market value or price of the share. Market price of share also fluctuates on the basis of demand & supply of shares in the market and speculation.
There are three stock exchanges on which the stocks/shares of public listed company are traded in Pakistan.
- Karachi Stock Exchange
- Lahore Stock Exchange
- Islamabad Stock Exchange
The shares can be brought or sold over the computer & telephone or through brokers which are connected with their agents working at stock exchanges. The payment can be made in bank of the stock exchange through brokerage account or through cash immediately after the trade.
Besides public listed companies, the stocks/shares of non-listed private limited companies can also be traded on the stock exchanges privately. But the Registrar of Joint Stock Companies and Corporate Law Authority should be informed.
Types of Shares / Stock
There are two Types of Shares / stock, which are as follow
- Common stock
- Preferred Stock
Common stock is the most general type of equity as compared to preferred stock. The Common Stock shareholders of the company have voting rights regarding the decisions of the management. The common shareholders receive dividend income from the net income of the company. This receiving dividend may fluctuate on the basis of the current year’s net income of the company and decision of the board of directors & management regarding the disbursement & reinvestment of the portions of net income. The expected price of the share is calculated from the cash flows associated with the common shares. The calculated expected price is then compared with the market value of the stock. Two types of cash flows are linked with the stock/share.
- Dividend Received by Shareholder:
The dividend received against common shares is unpredictable and fluctuating as compared to bond valuation in which there are fix regular payments over a period of time. This changing nature of dividend income makes the valuation of stock/share different from valuation of bond.
- Capital Gain
Increase in the value of assets is known as Capital Gain. You never recognize the level of increase in assets untill you did not sold them. Capital gain is also one way of raising capital from the market through shares.
Preferred stock is rare kind of equity and the shareholders holding preferred stock have priority or preference over the common stockholder in recovering their money in case of bankruptcy of the company. The preferred stock holders do not have voting rights. This kind of equity is also called hybrid equity because it contains the features of both stock & bond. Moreover the preferred stock holders obtains fixed regular dividend just like the coupon interest receipt of bond holder.