Shares

What they are

Shares are a way of participating in the ownership of a company. More specifically, one share is the smallest unit into which the capital of a certain kind of company (known as joint stock companies) is divided.

The face value of each share is normally determined by the company's bylaws; otherwise, the equity security itself must specify the total share capital and number of shares issued. The face value does not necessarily coincide with the value at issue (the shares can also be issued at above the nominal value, i.e. at a premium), or the market value (determined by the interplay of supply and demand).

Shares are negotiable instruments, i.e. instruments that incorporate a right that is easily transferred to another party. The incorporated rights and obligations can reside in the shareholder (registered shares) or in the person who holds the securities at a given time (bearer shares). Only savings shares can be bearer shares (click here to learn more).

Ordinary shares confer equal rights on owners, including voting rights in shareholders' meetings. There are, however, other categories of shares.

The corporate bylaws can envisage special 'categories' of shares, each with a different 'set' of rights. For example:

  • preference shares: assign special privileges - additional returns when dividends are decided or priority in the event of liquidation - but limit voting rights to extraordinary shareholders' meetings only;
  • savings shares: confer certain financial benefits (in the distribution of profits and capital repayment) but do not envisage participation in or voting rights at corporate shareholders' meetings. By law, these are the only shares that can be 'bearer' shares;
  • bonus shares: do not assign voting rights but enable holders to take part in the distribution of residual profits after the payment of ordinary shareholders;
  • enhanced voting rights and multiple vote shares: they have the same nominal value as other shares issued by the same company but confer a greater number of votes at shareholders' meetings.

Shares can be:

  • listed: the trading (purchase and sale) of securities takes place in the financial market;
  • unlisted: trading generally takes place directly through private agreements between shareholders and this can complicate their purchase and sale.

In Italy shares are traded on:

  • regulated markets: managed by special companies that adopt a regulation approved by Consob (the main operator in Italy is Borsa Italiana SpA); these companies guarantee that adequate information is provided on share issuers;
  • multilateral trading facilities (MTF): unlike regulated markets these can also be managed by companies other than market management companies (i.e. banks and Italian securities investment firms or SIMs) provided they have been authorized;
  • systematic internalizers: banks and other intermediaries authorized to trade financial instruments on own account or on behalf of clients;
  • over-the-counter (OTC): directly with their own financial intermediaries, outside of traditional markets.

Interested parties

Companies, because each share represents a way of financing their activities.

Investors/savers, because through the purchase of shares (the number is proportionate to the amount subscribed) they receive the right to participate in the administration of the company (such as voting rights in shareholders' meetings) and its profits (such as the distribution of earnings). Purchasing shares can represent a way of investing one's savings in an instrument whose return varies based on the performance of the company. The different 'categories' of shares give investors an opportunity to make investment decisions in line with their own strategies (depending on whether they are more interested in returns on investment or participation in the company's administration) and risk tolerance.

Strengths and drawbacks

To own shares means participating in the business risk of the company in which you have invested (this is commonly called risk capital). This in turn means that the return (dividend) will depend on the company's performance: if there is the possibility of higher earnings than for other kinds of security (such as bonds) - and it is vital that investors be aware of this - there is also a potential danger of losing all or a portion of the capital invested (risk). For example, in the event of the failure of the company and the liquidation of its assets.

Expenses

Strictly speaking, the costs linked to investment in equity securities are the fees owed to the intermediaries involved in the purchase and sale of the shares and their safekeeping (prospective shareholders must open a 'securities account').

Any earnings on the investment in equity securities are subject to tax.

Underlying rules

Possessing an equity security confers a number of financial and administrative rights on the owner:

  • the right to earn a portion of the profits established in shareholders' meetings by the company to be distributed in the form of a dividend;
  • the right to be reimbursed the value of the shares in the event of the company's liquidation (the value is determined at the time of liquidation);
  • the right to rescind or exercise an option (in the event of a capital increase);
  • the right to take part in or vote at shareholders' meetings;
  • the right to challenge invalid shareholder resolutions;
  • the right to obtain and verify information, for example by consulting the company's share registers and budget plan.

Pitfalls

Letting your emotions guide you: optimism, euphoria, pessimism, regret. These are all emotions that shape our investment decisions. Optimism, for example, might make us more likely to take on excessive risks. Or the fear of making mistakes could lead us to follow the crowd (an effect known as 'herd behaviour') even when this is not appropriate.

A lack of diversification: The value of a single share is tied to the fortunes of a single company; therefore to possess just one category of share is highly risky. The risk could be reduced by diversifying, i.e. by investing in different types of shares (for example, shares in different commodity sectors or countries). However, this practice is still not sufficiently widespread, especially among small investors.

Risk aversion: in order not to have to accept a loss linked to an investment, investors can decide to run other risks in order to 'break even', with potentially damaging outcomes. In fact, a number of studies have shown that the 'distress' felt following a loss is greater than the 'pleasure' of a gain. This is why investors tend to sell securities that are performing well early, thereby giving up on potential future revenue.

Keywords

RISK

The uncertainty and variability linked to the future value and return on a financial asset. In finance, the concept of risk takes on a dual connotation insofar as it can be also read as a profit 'opportunity'.