Why do investors buy shares?

Shares for Capital Growth

Capital growth is the increase in a value of a particular type of asset over time. People invest in shares because they offer the possibility that share prices will rise. A capital gain is the amount by which a market price of a share exceeds the initial purchase price of the share. However, there are instances where one could also make a capital loss.

Studies have shown that over the long term, investment in shares has provided greater returns than most other forms of savings or investments. Owning a share with a rising value allows you to grow your investment.

Shares for dividends

Dividends are returns paid to shareholders out of the company's net profits in terms of cash or shares. It is a way in which shareholders are rewarded for providing capital. Dividends are usually paid once or twice a year depending on the company's profit distribution policy. The rate of dividend paid too can vary depending on whether the company is trying to establish itself, in which case the rate would be lower. In comparison to a mature company which may opt to pay a higher rate, again depending on its policy of dividend payment.

Shares for liquidity and flexibility

Many investments are reasonably illiquid, which means they cannot be immediately sold and easily converted into cash. Shares give an investor a considerable amount of financial control because of their flexibility and liquidity. In particular ordinary shares are often considered the most liquid of investments. Unlike assets such as property one does not incur significant transaction costs or have to spend a considerable amount of time to buy and sell shares. A share transaction takes three days to settle. There is also a convenience of divisibility in shares. For example, if you own 5,000 shares, a portion of 1,000 shares can be sold.

Shares for diversification

Because there is an element of risk in any investment most investors utilise 'diversification' as a strategy to reduce and manage risk. The famous investment adage 'don't put all your eggs in one basket' is the best way to understand what diversification is. If equities are your sole investment, it makes sense to diversify between different companies and sectors. In this way, the loss made on some investments can be absorbed by gains made in others, keeping the overall return on investments positive.

Right to vote

A shareholder is entitled to participate and vote at Annual General Meetings (AGM) and at Extraordinary General Meetings (EGM) of the company, allowing the shareholder to influence important corporate decisions of the company.

Rights Issues

A Rights Issue is an issue of rights to a company's existing shareholders that entitles them to buy additional shares directly from the company in proportion to their existing holding, within a fixed time period. In a Rights Issue, the subscription price at which each share maybe purchased, in general, is at a discount to the prevailing market price. Rights are transferable, allowing the holder to sell them in the stock market. For example, a rights ratio of 1 for 2 means a shareholder can subscribe to one new share for every 2 shares already held by the shareholder. An investor owning 100 shares prior to the rights issue gets the right to subscribe for 50 new shares. A shareholder could also exercise the right to sell his "rights" instead of subscribing for the 'rights'.

Removal of adverse effects of inflation.

Shares are a good investment in an inflationary environment, since share prices adjust to protect investors from the effects of inflation.

Shares as collateral. Investors can use their share investments as collateral against loan facilities from banks.

Capitalisation of reserves/Bonus share issues.

Companies convert retained earnings (which represent the profits held in the business over time) to capital by issuing new shares to existing shareholders. The shareholders do not have to pay a consideration for these shares. For example, a capitalisation of reserve of 1 for 5 means that each shareholder receives one new share for each 5 shares held. An investor, who owns 100 shares before the capitalisation of reserves, receives 20 additional shares free.