Shares - how do they work?

[SoulKiss]

Probably one for Northy, but here goes.

My understanding of Shares is thus.

1) I have a company, it is valued at £100

2) I need £20 to grow, so I decide that I will create 100 shares, and sell 20 of them for £1 each, promising that each share will get 1% of Net Profit.

3) I make £50 profit, so I keep £40 and pay each of my shareholders £0.50 as a dividend.

4) I say that with the extra money I made I will be able to make even more next year, forecasting between £75 and £100 profit.

5) My shares are now popular and some of my shareholders are able to sell what they bought for £1 for £1.20, which on top of the £0.50 they earned as a dividend, made them £0.70.

6) I then make the £100 profit I had forecast, put the £80 profit in my bank and pay out a £1 dividend to those that have the shares.

Where is the connection between the share price and my company.

Surely when I got the money for the 20% of the company it separated the shares from me, my only connection/obligation being to pay the percentage of the profits to the shareholders.

If I make a loss I cannot claim that percentage back from them.

Where is this theory wrong, and if its right, why are we worried about share prices dropping?

Surely the only value of the shares are what people are willing to pay based on past returns and forecasted returns?

[Gazza77]

Probably one for Northy, but here goes.

My understanding of Shares is thus.

1) I have a company, it is valued at £100

2) I need £20 to grow, so I decide that I will create 100 shares, and sell 20 of them for £1 each, promising that each share will get 1% of Net Profit.

3) I make £50 profit, so I keep £40 and pay each of my shareholders £0.50 as a dividend.

4) I say that with the extra money I made I will be able to make even more next year, forecasting between £75 and £100 profit.

5) My shares are now popular and some of my shareholders are able to sell what they bought for £1 for £1.20, which on top of the £0.50 they earned as a dividend, made them £0.70.

6) I then make the £100 profit I had forecast, put the £80 profit in my bank and pay out a £1 dividend to those that have the shares.

Where is the connection between the share price and my company.

Surely when I got the money for the 20% of the company it separated the shares from me, my only connection/obligation being to pay the percentage of the profits to the shareholders.

If I make a loss I cannot claim that percentage back from them.

Where is this theory wrong, and if its right, why are we worried about share prices dropping?

Surely the only value of the shares are what people are willing to pay based on past returns and forecasted returns?

Like houses, people are worried their shares are worth less than they paid for them, or less than they used to be. Unless you planned to sell them, or the company goes into liquidation or is nationalised (banks :rolleyes:) then it is only a paper loss rather than a real one. Prices can and do go up as well as down...

[SoulKiss]

Like houses, people are worried their shares are worth less than they paid for them, or less than they used to be. Unless you planned to sell them, or the company goes into liquidation or is nationalised (banks :rolleyes:) then it is only a paper loss rather than a real one. Prices can and do go up as well as down...

My point is not about the shares - its the link that the shares have to the business AFTER the capital has been raised by the event of the share issue.

ie, how does the share price of a bank dropping mean that its actually worth less, there is no less cash in the vaults etc....

[the_lone_wolf]

Shares - how do they work?

they don't...


haven't you been watching the news?;)

[thor]

The value of a share is supposed to represent the current value of the future revenue stream from dividends. In practice it is anything but, because short term outlook is driven more by market speculation and sentiment.

[thor]

Sometimes the value of shares can affect the finances of a firm indirectly. It can affect their borrowing costs and also it can affect how much they can raise by issuing new shares.

However, the share price dropping is supposed to mainly represent the fact that the firm is doing worse, and will therefore not be able to pay out as much in dividends in the future.

[embee]

You're trying to be too logical about it. Shares are just what it says, it's a "share" in the ownership of the company.

Someone starts a private company, it does well, grows, the owner/s want to realise some of the "value" so float the company on the stock exchange. Its value, and the value of the shares, is whatever the investors think it's worth, just like selling anything. They'll weigh up what they think the company potentially offers in growth and dividends (think of dividends in a similar way as interest on savings, may be more, may be less, may be nothing, no guarantee) and the share price will end up at whatever investors are prepared to pay. The market-makers do the deals and try to run the price up as much as they can until people stop buying, then that's the value.

The shareholders then own the company and can vote on how it's run.

If it does well then other investors want part of it so are prepared to pay more for the shares, if it goes down the pan the shareholders lose their investment.

The share value is simply whatever you can get for them, there's a lot of sentiment/feeling/herd mentality involved, not much logic.

[SoulKiss]

You're trying to be too logical about it. Shares are just what it says, it's a "share" in the ownership of the company.

Someone starts a private company, it does well, grows, the owner/s want to realise some of the "value" so float the company on the stock exchange. Its value, and the value of the shares, is whatever the investors think it's worth, just like selling anything. They'll weigh up what they think the company potentially offers in growth and dividends (think of dividends in a similar way as interest on savings, may be more, may be less, may be nothing, no guarantee) and the share price will end up at whatever investors are prepared to pay. The market-makers do the deals and try to run the price up as much as they can until people stop buying, then that's the value.

The shareholders then own the company and can vote on how it's run.

If it does well then other investors want part of it so are prepared to pay more for the shares, if it goes down the pan the shareholders lose their investment.

The share value is simply whatever you can get for them, there's a lot of sentiment/feeling/herd mentality involved, not much logic.

Again I understand that - I think I covered it in my original post.

Its how does the price of these bits of paper that only promise to pay if there is a profit, losing value can cause a bank/company to "fail".

I'm looking for the connection.

The closest I see is when they borrow against the value of the company which they work out using the fact that shares are worth £1, we have 1000 of them, therefor we can borrow against that £1000 valuation.

If that IS the case then how is it that the "Money Brains" cant see what I can - that its a load of rubbish and stupid to boot........

[600+]

If that IS the case then how is it that the "Money Brains" cant see what I can - that its a load of rubbish and stupid to boot........

they can and they new about it at least 2 years ago when they were reviewing their portfolios ;) they chose to do nothing about it since the market seemed full of pace for growth. what you see now is every skeleton that has been left in a clauset

[punyXpress]

ie, how does the share price of a bank dropping mean that its actually worth less, there is no less cash in the vaults etc....[/quote]
There's no cash left in the vaults cos Brown G nicked it all.
Most share prices are only influenced by ' the institutions ' so thee & me don't count.

[muffles]

So the question is how does the share price affect a company's ability to continue trading, I think?

I'm not an expert, but I do work for a bank that went through this last year (let's call them Storgan Manley).

I think the root problem is it affects market sentiment. So, if there is a run on your shares and the value's dropping like lead, outsiders see this and believe the company's about to go under (since the share price is supposed to reflect the company's value to some degree).

As a result several things can happen - loans can be called in, credit lines cut, all the things that are needed to continue trading. Also I think in some cases companies pay for their own credit default swaps - the insurance against them defaulting - i.e. someone lends your company £100 and you pay a certain amount to someone else to insure that back to the person you owe it to. This figure is basically like the price of any other security and decided by the market, so along with your loans being called, your credit gone, anything you DO find to lend will probably result in you paying a huge amount to also insure that debt.

It's all a self-fulfilling prophecy in my mind, and I was (sort of) in the middle of it looking at the numbers going "what the?!" when it happened to my company...

[embee]

There's nothing to connect share price to the viability/prospects of the company other than what investors think. Share price isn't connected to capital or underlying intrinsic value, think maybe Railtrack or similar, lots of real-estate which in theory had a lot of value, but the company wasn't a going concern so who wanted to own a part of it?

Share price reflects what investors think, not the other way round. Having said that, the herd mentality or lemming effect or bandwagon often drives things unrealistically (e.g. the dot.com bubble), and it usually ends in tears.

Very often whole sectors go up or down, and logic says not every company in the sector is doing well or badly to the same degree, but the markets tar them all with the same brush to a large extent.

[muffles]

There's nothing to connect share price to the viability/prospects of the company other than what investors think. Share price isn't connected to capital or underlying intrinsic value, think maybe Railtrack or similar, lots of real-estate which in theory had a lot of value, but the company wasn't a going concern so who wanted to own a part of it?

Agree with your general sentiment but I'd say the 'value' of a company *is* reflected by the share price - it is, after all, the market's valuation of the company. If it's unjustified is another matter, but for one reason or another the market will believe it to be only worth that amount.

[SoulKiss]

Agree with your general sentiment but I'd say the 'value' of a company *is* reflected by the share price - it is, after all, the market's valuation of the company. If it's unjustified is another matter, but for one reason or another the market will believe it to be only worth that amount.

I would have thought the "value" of a company = cash in bank + Physical assets - debts........

Not pie-in-the-sky valuation of little bits of non-money paper (share certs)

[muffles]

I would have thought the "value" of a company = cash in bank + Physical assets - debts........

Not pie-in-the-sky valuation of little bits of non-money paper (share certs)

That's part of the valuation of a company but there's other parts of the valuation I believe, that's where the market sentiment comes in - and that value can be positive or negative so you could go below the value you indicate above.

Also there's often trouble valuing assets which is what happend (hence all the writedowns).

E.g. I owe you £100, that £100 is an asset to you. So do I value you at £100? Well, in an ideal world, where everyone pays their debts, yeah. But if someone bought you for £100 and then I went bankrupt and paid you 10p in the pound (so £10) you are only "worth" £10.

The share price would be indicative of how "safe" my debt was, if I was 100% "safe" you'd obviously be worth £100 cos you'd get that whatever happened. But if I'm a bit flaky and there's a 50/50 chance of me defaulting, your share price might only value you at £55 (£100-£10 / 2 - just a calc for example's sake as I don't know how they really work it out).

[thor]

I would have thought the "value" of a company = cash in bank + Physical assets - debts........

+ future profits...

thats the pie in the sky bit

[muffles]

p.s. the other parts of the valuation I referred to are things like ability to continue trading, e.g. if you worked out the value (as you did above) at £100 but the company has the potential to grow exponentially and become worth many times that...the valuation would naturally increase. Again this is subject to many factors and can be wrong...and can also work the other way (company looks like it has the potential to lose lots of money and as such the valuation is low, because no-one wants to pay "asset value" for a company that will then go on to lose them more dosh).

[saintnick]

Where is this theory wrong, and if its right, why are we worried about share prices dropping?

In the normal course of events, profit and loss is relatively predictable.

The problem at the moment - a consequence of the global economy= global deregulation BTW - is that losses are becoming exponential, because corporate assets (and therefore valuations) have (predictably) turned out to be largely worthless. If valuations have turned out to be iffy, suddenly everything related to those valuations becomes infected.

The LLoyds/HBOS thing is a perfect paradigm. Lloyds had been well managed, producing regular steady profit margins - nothing too spectacular - and seen as a reasonably safe bet. But as soon as they took over HBOS, £4.00 a share became 40p a share, although the rest of LLoyds was still fine. But HBOS were/are totally fcked, and anyone getting into bed with them has to have assets greater than the concomitant degree of exponential exposure. G.Brown was warned.

This example may help, then again it may not........ Another way of looking at it: if we can no longer assume the credibility of valuations (specifically 'assets'), shares become meaningless.