What are shares?

When registering a company, the company is broken down into smaller pieces which are distributed to the owners of the company. These smaller pieces are called shares. The amount of shares comprising a company is not specified or limited. As a result, if you own 10 shares in a company, you need to compare this to the total amount of shares that are issued. If for instance, the total amount of issued shares is 100, your 10 shares represent 10% of the company. The owners of companies are called shareholders.

Shares can either be private or public. When companies require large amounts of capital for expansion, they take the company public through what is called an Initial Public Offering (IPO). They start by determining what the company is worth. This will typically be a multiple of the total earnings of the company, adjusted for the expected future earnings potential of the company. These are then sold via platforms like the Johannesburg Stock Exchange (JSE), or the New York Stock Exchange (NYSE) to the public.

The total amount of shares is not a fixed amount. Companies can decide whether they want to increase or decrease the amount of shares in issue. When the shares are reduced, the company needs to buy the extra shares back from the shareholders in what is called a share buyback. This is done with profit from regular operations. This increases the value of the remaining shares since the company is divided into fewer smaller parts. This is obviously beneficial to shareholders.

If the company requires more capital, they can issue more shares. During such a share issue, the value of the other shares are diluted and as a result lose their value. This happens during two scenarios. One, the company is struggling financially and need cash to keep them afloat, or two, the company wants to fund additional purchases in the hope that they will increase their revenue in the future. The second option is obviously the preferred reason.