Demystifying stock markets

Stock brokers monitor trading activity at the Uganda Securities Exchange in Kampala. Prices of stocks can go up as well as down basing on a variety of factors such as supply and demand of shares on the market. FILE PHOTO

What you need to know:

Just like any other market, broadly speaking, a stock market is a place where buyers and sellers meet to trade or exchange items at an agreed price. Once listed, the issued stocks can be traded by the investors in the secondary market. This is where most of the trading happens. Mark Kamugisha helps us understand stock markets better.

Stock market investing is often portrayed as something difficult and complicated to do. This is not necessarily true and in the following few paragraphs we hope to dispel this myth.
Firstly, a market is a place where buyers and sellers come to meet and transact at a price acceptable to both parties. In the case of a stock market it may also be called an exchange, for example, Uganda Securities Exchange. However, it remains a place where buyers and sellers meet to trade or exchange items at an agreed price.
Secondly, stocks, equities and shares are all basically the same thing. They represent a piece of ownership in a company.
Companies are familiar to us all and provide a wide range of goods and services to their customers. These companies exist to generate profits for their owners.
These owners are often called ‘shareholders’. This is because they ‘hold’ a share of the company. They become owners by buying a share of the company, providing what is known as ‘equity’.
In its simplest form, equity is the capital put into a business to allow it to provide the goods/services from which it can generate profits. Capital may be used to purchase land, machinery, and other things used in business.

In case of success
When a business is successful in its operations, profits will be generated. These profits can then be shared out between the owners. This payment of profits to the owners is called a dividend. Shareholders receive dividends in proportion to their shareholding. If I own 50 per cent of the shares of a company (assuming all shares are of the same class), I should receive 50 per cent of the dividend paid out.
Companies listed on the stock market are referred to as public. This is because they can be bought and sold publicly.
When a company is planning to offer shares to the public, it is known as an Initial Public Offering (IPO). They are making available, for the first time, the opportunity to purchase a share of ownership. Upon completion of an IPO the shares are said to be ‘listed’, this simply means that they are placed on an exchange where buyers and sellers can trade them.
Traditionally, there was literally a list on a large board where buying prices and selling prices were written. These days most markets are electronic and buyers and sellers in-put orders via computers.
To buy or sell shares/stock/equities – we need an intermediary. Much in the same way we approach a broker to buy or sell a plot of land – stockbrokers exist to help match buyers and sellers for a fee.

Price fluctuations
The prices of stocks go up as well as down. They fluctuate based on a variety of factors such as supply and demand of shares; outlook for the company; prospects for the economy and investor sentiment. If the outlook is positive buyers should be willing to pay more in the hope that businesses will generate greater profits. This can drive stock prices higher. Should the outlook turn negative investors may seek to put their money elsewhere and sell, lowering prices. Investors in the stock market should have a medium to longer term view (5 years plus) and be prepared for fluctuations in the value of their shares.

Why invest in the stock market?
Stock market investing has two aspects, capital gains (rise in share price) and income (dividends). The value of your shares may rise providing you with a capital gain. Over time, if a company is successful, profitable and expands it should become more valuable, making its shares worth more. The growth in share price can be considerable. If you buy a share for Shs100 and the price rises to Shs200 that is a 100 per cent gain on initial investment.
However, it is important to note, that when you invest in stocks your capital is at risk. You could buy a share for Shs100 and its price falls to Shs50 representing a 50 per cent loss on your initial investment.
As an owner you are entitled to a share of the profits and will receive dividend income. You will receive dividend payments as cash. For example, if you purchase a share at Shs100 and it pays you a dividend of Shs20 per year, after five years not only will your original investment be repaid, but you will continue to receive further dividend payments. However, we must also consider that businesses can struggle and may not make profits, in which case the management may opt not to or be unable to pay dividends.
Historically, the most successful stock market investors Warren Buffett and company have made the bulk of their wealth from holding stock for long periods of time and re-investing dividends. These investors take the dividends they have been given and buy more stock. This has a similar effect to compound interest.
The ultimate aim of investing is to grow wealth. This makes the stock market one of the ideal vehicles with which to grow wealth over the medium to long term (5 years plus).
Another reason aside from potential value gains and income is that stocks have historically managed to grow faster than inflation. Inflation is bad for wealth, as the value of goods and services rise this reduces the purchasing power of your money.
However, as the price of goods and services rise, most companies are able to raise prices. This, therefore, is beneficial to you as an owner/shareholder.
An additional benefit to holding shares is that you can sell them easily as and when you need to. Unlike, for example, a plot of land there are typically buyers and sellers readily available.

How do I invest in the stock market?
One can appoint a stockbroker, fund an account and give them instructions to buy or sell individual stocks. To make effective stock picks one must understand the underlying dynamics of the business well and its prospects. Detailed research is vital to good decision making.
Alternatively, one can put money in an investment fund. Investment funds are collective schemes where members of the scheme can input money at regular intervals. The fund pools this money and purchases stocks. Most individual investors are likely to find it easier to drip-feed money into the stock market in small increments.
Most investment funds buy a variety of equities which also provides a measure of protection via diversification. Diversification spreads risk. This means that instead of being exposed to one stock, you own more stocks which can provide protection as some stocks may fall as others rise.

This article does not in any way constitute investment, tax or legal advice. It is recommended that you seek professional investment advice before investing in the stock market.