What are stocks and how do they work between investments and the stock market?

Knowing specifically what are shares and how do they work is necessary first of all for those who want to try their hand at a financial investment.

Shares, in fact, are the preferred instruments, together with bonds, of investors passionate about Stock Market. According to a survey by Scalable Capital in 2023, 40.9% of Italians who decided to invest did so in the capital market, opting for shares, bonds, funds and ETFs.

Shares understood in the most general sense of the term, however, are not only those listed on the financial markets, but they generically correspond to a part of a company.

To understand what shares are and how they work, especially if understood as investment instruments on the stock market, the main characteristics are explained below.

What are shares: meaning and definition

A simple and clear definition to understand what shares are comes from the Bank of Italy website, where it says:

"shares are an instrument of participation in the ownership of a company. In particular, a share represents the minimum quota into which the capital of a particular type of company is divided (precisely called joint-stock companies)."

This means, consequently, that a person can purchase shares of a company, which are participatory securities and give the owner the qualification of member which entails the acquisition of a series of economic, participation, information and control rights.

The shareholder, therefore, as specified by Consob:

"is a member, and not a creditor, of the company and therefore participates in the economic activity of the company itself, bearing the risks in the event of losses. Risks, however, which are limited to the value of the shares owned."

Shares usually have the same value and confer equal rights. The company bylaws, however, may provide for different categories of share certificates, such as:

• preferred shares: they grant particular privileges such as higher returns or pre-emptive rights in the distribution of assets in the event of liquidation. The right to vote, however, is granted only at extraordinary meetings;
• enjoyment shares: they allow participation in the distribution of profits that remain after payment to ordinary shares, but do not give the right to vote at the meeting;
• savings shares: they offer economic advantages in the distribution of profits and in the reimbursement of capital, but do not allow participation and voting in company meetings;
• shares with increased and multiple voting rights: these are those that give a greater number of votes during company meetings.

Finally, a distinction is made between listed shares and unlisted shares. The former are bought and sold on the financial market; the latter through private agreements between shareholders.

Shares may provide for a remuneration for those who own them, called a dividend.

The value of shares

It is important, in order to understand and deal with stocks, not to confuse the following information:

• nominal value: the value of the share of the share capital represented by each individual share;
• equity value: this is obtained by dividing the company’s net equity by the number of shares. This value varies over time depending on the economic events that affect the company and can be ascertained through the financial statements;
• market value: is the value that appears every day on the official stock exchange lists and indicates the trading price of shares. Studies carried out over the years on stocks have focused on their market value and on the study of the factors that influence it to derive financial models capable of predicting its dynamics.

How do stocks work on the stock exchange

Listed stocks or equity securities are those traded on the stock exchange.

Specifically, as indicated in a Money.it article, the stock market is not a physical place where the buying and selling of securities takes place, but a electronic place, where shares are bought and sold, i.e. goods that are also not material.

They are distinguished by the primary market, where newly issued stocks by the company are traded, and the secondary market, where securities that are already in circulation are bought and sold.

How do stocks work on the stock exchange specifically? Through financial intermediaries, such as banks or online brokers, investors can purchase company shares at a price, the market price.

The price of a share and its variations on the market are determined by various factors:

• performance of the company’s results;
• expectations about its future performance;
• growth prospects of the sector in which the company operates;
• performance of the economy in general

By owning company shares, you acquire the rights associated with that type of stock purchased, in addition to obtaining an investment. If the price of the share rises, in fact, you can sell it and obtain a profit.

What does it mean to invest in shares?

Investing in shares, therefore, means buying shares of companies to become, at least in part, owners and to do so in the stock market.

As these companies grow and become successful, the value of the investment in the shares also increases. However, market volatility and factors related to the national or global economic situation or drops in production and turnover of the specific listed company can be risks and cause the value of the shares purchased to decrease.

In this regard, scholars in the sector have proposed two types of analysis:

• fundamental analysis: based on the estimate of the value of the shares through the study of the relationships between economic quantities connected to the situation of the issuing company;
• technical analysis: based on the study of the price trend. In this type of analysis, we do not take into consideration why the price of a stock changes over time, but how it changes.

What can help us understand which stock will increase in value, thus making us obtain profits, is undoubtedly the sentiment of investors. We must consider not only the company from which we want to buy the shares, but also the reference sector.

We must also keep in mind the competitors and the historical and political moment in which we are buying the shares. Furthermore, you should understand what the political appointments will be, both internal and external to the country, which could cause an upheaval in the market.

Once you have analyzed all these factors and drawn up a good money management plan, it will be time to invest in the stock market and buy stocks.

The difference between stocks and bonds

When you are a beginner, you tend to confuse two concepts that are actually very distinct: bonds and stocks.

By buying stocks, unlike what happens with bonds, you are not making a loan to the company, but you are providing risk capital. The bond, on the other hand, is nothing more than a part of the corporate debt that the investor purchases by receiving a return (the coupon) every six months or quarterly.

The periodic coupons provided by a stock (dividends) are not certain, but variable and dependent on the evolution of the issuing company’s profits and its distribution policy.

Another difference between stocks and bonds concerns the duration of the life of these financial instruments. Stocks have indeterminate maturity and can provide potentially unlimited cash flows over time and, furthermore, do not provide any guarantee of recovery of the initial capital.

Bonds, on the other hand, have a well-defined duration and above all have a very clear and defined return for the buyer. The invested capital is returned plus the accrued interest.

Original article published on Money.it Italy. Original title: Cosa sono le azioni e come funzionano tra investimenti e borsa