What are stocks and shares, and should you invest in them?

For first-time investors, continued references to ‘stocks’, ‘shares’ and ‘equities’ might lead you to think that they are all different things. However, they are all just different names for the same thing.

It’s easiest to think of a ‘share’ as just that. If you buy shares in a company - such as Lloyds, for example - you are literally buying a share in the company’s business. For that investment, you are entitled to part of the company’s future income and profits in the form of dividends. You also hopefully benefit from your shares going up in value if the business is successful.

Ownership of the shares also gives you the right to take part in the company’s annual general meeting, to vote on certain decisions put forward by the board, as each share carries a vote, and to buy shares in any new issues the company might make to fund its growth.

Buying and selling

Shares are bought and sold on the stock exchange. Back int he 80s, shares were traded face-to-face on the floor of the London Stock Exchange itself.

The stock ‘broker’, who was buying or selling shares on behalf of their clients, would negotiate in person with a stock ‘jobber’, whose job it was to make a continuous market price in a given list of shares.

Trading eventually moved to computer screens with the ‘jobbers’ making prices and the ‘brokers’ buying or selling electronically or by telephone. This is still the case today.

Why buy shares?

Historically, the case for owning shares is strong. The 2024 iteration of a big study into how stock markets around the world have performed, called the Barclays’ Equity Gilt Study, shows that £100 invested in cash since 1899 would be worth just over £22,000, while the same amount invested in UK government bonds would be worth just under £36,000. However, if you had invested £100 in UK shares in 1899, they would have been worth around £3.7m today.

As these figures show, over the long run the returns on shares are much higher than the returns on cash and bonds, but those returns are also much more volatile.

While the returns on bonds and cash are reasonably predictable, the returns on shares can vary hugely over short periods, as the performance of the stock market this year has demonstrated.

Whereas bonds pay a fixed rate of interest, and at some point the company or the government pays back the loan and the investor gets back their original investment, shares are an actual stake in a company’s assets and profits.

If a company fails to grow its profits much, its shares will perform poorly. If the company gets it completely wrong and goes bust, however, shareholders may not even get their money back.

Risk versus reward

If you might not even get your money back, you might wonder why you should buy shares at all. The answer is that, broadly speaking, higher risk leads to higher returns.

If you aren’t comfortable with the risk that, in order to generate higher returns by buying shares you might lose some or all of your investment, then you should probably stick to cash, bonds or other assets, such as property.

If you are comfortable with that risk, then you need to set yourself reasonable expectations. Success in investing isn’t instant, nor is it easy - otherwise we’d all be millionaires within a year.

Mistakes are par for the course

Building long-term wealth takes time and patience, and a willingness to accept losses as part of the process. No professional fund manager on the planet gets every investment decision correct, so it's unrealistic to think you won’t make mistakes along the way.

One of the most common mistakes that investors and analysts make is to be too confident in their forecasts for companies’ profits. Quite often they focus too much on what a company is good at and not enough on what it is bad at or what could trip up their forecasts.

Information provider Reuters provides, free of charge on its website, consensus estimates for sales and earnings per share (EPS). Also, many larger companies have an ‘Investors’ section on their website with a range of analysts’ forecasts.

Usually, looking at the consensus range of forecasts is better than looking at one single forecast, and if a company’s shares look cheap on even the lowest profit forecast then it is probably worth further investigation.

Source: Barclays Equity Gilt Study 2024

How do I buy a share?

Once you have opened an account, you can search for the company, investment trust or exchange-traded fund you are interested in.

Before buying it (also called ‘dealing’), you should be able to find essential information on your investment platform, such as a company’s financial and dividend history, details of an investment trust’s holdings or the index being tracked by an exchange-traded fund. You can also find this information and more from financial websites such as Morningstar.

To buy a share, you either enter the number of shares you want or the monetary amount you would like to spend. The latter option will figure out how many shares you can buy at the current price. You should be able to specify whether you want dealing charges included or excluded as part of this figure.

There is no recommended amount of shares you should buy in a company, although you should bear in mind the dealing costs you can incur. It would not make sense to buy one share costing 500p, for example, as you could pay twice that amount as a transaction fee.

It is important to understand the distinction between the bid and offer price. The former is the price you’ll achieve if you sell (i.e. what a market maker will bid for your shares), the latter represents the purchase price (i.e. the price that a market maker will offer you).