What is a Stock Market?
A Stock Market is an important part of modern economies. The Jamaican stock market is a vital link between companies needing capital and Jamaicans with money to invest. Through investments in stocks, investors become part owners of the companies of their choice and are able to participate in the companies’ growth and development. In turn, companies which raise capital from the sale of shares are able to expand. This helps to increase employment both directly and indirectly as more raw materials and services are bought and additional suppliers and contractors are hired. The increased economic activity helps to increase production and strengthen the country’s economy as a whole.
What is a Share?
A Share is a unit of ownership interest in a company. When you buy or receive shares in a company, you become a part owner of that company. This is also known as having equity in that company. The more shares you have in relation to the total number of shares issued by the company, the more of the company you own. For example, if a company has issued 10, 000 shares and you own 100 of those shares, then you are a 1.0% owner. If another person owns 1,000 shares, then the person is a 10.0% owner. People who own shares in a company are referred to collectively as “shareholders” or “stockholders”.
A company may also be authorized to issue more than one class of common stock or shares, some of which may not have voting rights. (Not all companies have this provision.)
Are there different types of Shares?
Yes, there are two basic kinds of shares:
Also known as “common stock”. As a part of the percentage ownership described earlier, the ordinary shareholder or common stockholder usually has four basic rights in proportion to the number of shares owned:
- The right to receive dividends if and when these are declared by the Board of Directors. It is possible that the shareholders may not receive any dividends if the company performs poorly.
- The right to a vote at meetings of the shareholders.
- The right to claim a portion of the company’s undivided assets, if the company is liquidated.
- The right to subscribe to additional stock or share offerings before they are made available to the general public. This is known as a pre-emptive right.
Also called “preferred shares or stocks.” The holders of these shares have certain rights and privileges over ordinary shareholders. There are different classes of preferred shares, which confer different rights. The most common types give the preferred shareholder:
- The right to receive dividends at a fixed rate prior to payment of dividends to ordinary shareholders.
- The right to receive a proportionate share of the company’s assets before ordinary shareholders, if the company should go bankrupt or be dissolved for any reason.
What is a Dividend?
A dividend is a proportionate distribution of earnings (profits) of a company to its shareholders. With common (ordinary) shares or stocks, the rate of the dividend varies with the company’s performance and with the amount of cash on hand. With preferred stocks or shares, the rate is fixed.
The Board of Directors of the company decides the amount of the dividends to be paid out. They may also decide to hold back some or all of the profits to expand the company’s operations. Dividends can be paid quarterly, half yearly or once per year.
How do I determine which shares to buy or sell?
The general principle is that investors should buy undervalued stocks and sell overvalued stocks. There are different models used to value a stock. A few of which are:
- The Dividend Discount Model (DDM) values a stock by projecting dividend payments and discounting them back to the present value.
- The Free Cash Flow to Equity Method (FCFE) gives an indication as to how much cash is available to the shareholders. This method discounts cash flow available to shareholders by the cost of equity and the result therefore is the value of the firm.
- The Price Multiples Approach (eg. P/E ratio) assumes that if firms are comparable, we can use the multiples approach to derive the value of one firm based on the value another.
- The Enterprise Value to EBITDA ratio (EV/EBITDA) recognizes the value to all the firm’s capital providers. This method is calculated by dividing the total value of the firm (enterprise value) by earnings before interest, tax, depreciation and amortization (EBITDA).
These valuation models derive the stock’s intrinsic value which is compared to its current market value. If the intrinsic value is lower than the market value, the stock is said to be overvalued. Conversely, if the intrinsic value is higher than the market value the stock is said to be undervalued.
What are some of the indicators that help investors/analysts interpret financial statements?
There are also several indicators that help investors/analysts interpret financial statements so as to assess the performance or health of a company. Some of the commonly used ratios are:
- P/E Ratio: The company’s share price relative to its earnings per share
- Book Value per Share: This represents a per share assessment of the company’s equity.
- Current Ratio: A measure of a company’s ability to meet its short-term obligations.
- Net Profit Margin: This is the percentage of revenue remaining after all expenses, interest, taxes and preferred dividends are paid.
- Return on Equity: The returns earned by shareholders on their investments in the firm.
- Return on Assets: The returns earned by a firm on its assets.
- Dividend Yield: This shows how much a company pays in dividends relative to its share price.
- Debt to Equity Ratio: The proportion of debt and equity a firm uses to finance its operations.
- Price/Book Value (P/B): This ratio compares a stocks market value to its book value.
How do I buy and sell shares?
Contact your VM Wealth Advisor and advise him or her to buy or sell shares on your behalf. Give him or her clear instructions, whether orally or in writing. The buying/selling process begins when you place the order with your stockbroker for a specified number of shares in a company. There are three types of orders that you can place:
- A market order – asks your broker to buy or sell stock at the market price.
- A limit order – sets the price at which you want stocks to be bought or sold.
- A stop order – which gives an approximate buying or selling price of stock. When the approximate price is reached the stop order becomes a market order.
What are some other frequently used terms associated with stocks?
YTD Change: Year to Date changes in stock price
YOY: Year over year. Used when comparing a company’s current results with that of the previous year.
52-week Range: The highest and lowest stock price within the last year.