Understanding Stocks and the Stock Market

Introduction

In Ghana, there seems to be a lot of activity on the stock market with companies selling shares/stocks or planning to issue shares on the Ghanaian market. The question is: “what are shares; and what is the Ghanaian understanding of how the stock market works?” The purpose of this article is to explain what stocks are, types of stocks and how the stock market works to the average Ghanaian.here have been numerous financial literacy forums and clinics on the importance of investment to every individual. Every day in our media we are bombarded with commercials of numerous investment houses selling a variety of investment products to potential investors. Indeed, there are a lot of investment options available to every investor – and stocks/shares is no exception.

What is a stock/share?

Shares/stocks (also known as equities) represent a part ownership in a firm. A company seeking funds to undertake various projects has two sources of funding: debt or equity. In other words, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. Borrowing by taking a loan from a bank or by issuing bonds is termed debt financing, while issuing stock is called equity financing. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.

The returns or profit to shareholders come in the form of dividends (when declared by directors) and capital gains (when the selling price of a share is higher than the initial purchase price). The risk associated with every stock is that there is no obligation to pay out dividends, even for those firms that have traditionally given them, so there are no guarantees when it comes to shares/stocks.
Types of shares

There are two types of shares, namely ordinary shares (common stocks) and preference shares (preferred stocks). Ordinary shares are shares that entitle holders with the right to any residual income of the company after all liabilities have been paid. Ordinary shares holders also have the right to vote on certain important issues and decisions of the firm; such as election of board of directors, adoption of bye-laws and authorisation to issue new shares.

It is important to note that in the long-term ordinary shares, by means of capital growth, yield higher returns than almost every other investment. This higher return comes at a cost, since ordinary shares entail the most risk. If a company goes bankrupt and liquidates, the ordinary shareholders will not receive their money until the creditors, bondholders and preference shareholders are paid.

Preference shares, on the other hand, represent ownership interest – except that unlike ordinary shares they come with no voting rights. Holders of preference shares receive fixed annual dividends and are preferred when it comes to dividend payments; that is, preference shareholders are paid before ordinary shareholders.

Furthermore, preference shareholders do not participate in the sharing excess income of the company when it’s declared. Preference shares may be cumulative or non-cumulative. Cumulative preference shares entitle the holders to receive any unpaid dividends at a future date when dividends are declared, while non-cumulative preference shareholders do not enjoy this benefit.

How Stocks are Traded (Primary Market vs Secondary Market)

Shares can be issued either through private placements or public placement. Private placement means that the issuing firm/ the issuer contacts a few (usually) institutional investors to buy the shares, which means that the issue is not available to the general public for participation. In public placement, the issue is targetted at the general public.

In the capital market (where long-term funds are traded), the primary market is that part of the market which deals with issuing new securities. Initial Public Offerings (IPOs) refer to issuing shares to the general public by a public company or a private company that has just gone public. IPOs are done in the primary market and the funds raised go directly to the issuing firms. A firm can also raise additional shares (often called a rights issue) to expand its operations after an IPO through a secondary offering.

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Secondary markets provide opportunities for existing shareholders/investors to buy and sell securities they already own. It is what most people typically think of as the ‘stock market’. Funds raised on the secondary market do not go to the firms that issued the shares, but directly to owners of the shares/investors.

In the secondary market shares can be traded Over-the-Counter (OTC) or on Stock Exchanges. The OTC market trades shares through a dealer network rather than through a centralised stock exchange. There is no trading floor or specific location, therefore trading in shares is done through a telecommunication network. Shares trading on the OTC market in Ghana includes Accra Hearts of Oak, Donewell and Shell.

Stock exchanges have a centralised system or electronic platform through which stock brokers trade in shares for their clients. Examples of stock exchanges include the Ghana Stock Exchange, Malawi Stock Exchange etc.

How the Stock Market Works

Buying a share of stock in any publicly traded company will most likely require the services of a brokerage firm. Due to the fact that the securities industry is highly regulated, one can’t just start selling stocks to the general public unless you’re properly registered and licenced.

A brokerage firm is a dealer of stocks and other securities that acts as an agent when you want to buy or sell stocks. In other words, the brokerage firms acts as the representative of the investor wishing to buy or sell stocks on the floor of the stock exchange. The brokerage firms trade stocks for their clients through highly-trained professionals called Authorised Dealing Officers (ADO’s). An ADO is a broker licenced by the Ghana Stock Exchange to trade in securities.

A prospective investor on the Ghana Stock Exchange (GSE) must first open a securities account with a brokerage firm before trading in securities.

To begin the process, one must make contact with a broker to complete an account opening form and place an order for the purchase of shares. If the order is executed, within a day or two, you’ll receive confirmation that your order has been completed, and you’ll be the proud new owner of a stock.

Behind the scenes, however, there’s a lot of activity that takes place between your order and the confirmation. Here’s what happens with the Electronic process in Ghana with the availability of the Central Securities Depository (CSD):

Shares must be available on the CSD

  1. The investors complete a sale/purchase order form that will state all details surrounding the sale/purchase of stocks.
  2. The forms are forwarded to the settlement desk for verification of signature and availability of shares among others.
  3. The trading desk enters the order on the Terminal Work Station (TWS).
  4. The trader puts the shares on the market awaiting a buyer or seller.
  5. The trade is then executed for the investor.
  6. The trader sends a confirmation note that displays details of the executed trade to the investor.

Previously, a hard-copy of a share certificate was issued after the purchase, but with the introduction of technology an electronic certificate is now issued.

When is the Best Time to Buy Stocks?

Identifying the right time to buy stocks is a key to success in the stock market. One of the basic principles of stock investment is to buy low and sell high. The best time to buy stocks is when the prices are as low as they could possibly be.

The following are the key factors and tips that you need to look at when finding the best time to buy stocks or shares:

1) The best time to buy stocks is during a recession: When industry is in a recession, it is definitely the right time to start searching for company shares that are selling for less than they are actually worth. During a severe recession, share prices on premium companies can be very attractive, and that will be the right time to enter the market.

2) Another best-time to purchase stocks is when there is a new public offering: When a new company reaches a certain stage in its growth, it may decide to go public with an initial public offering (IPO). An IPO can be viewed as the ultimate sign of a company’s success. Historically, IPOs have always been underpriced. This can lead to significant gains for those who have bought an IPO at the offering price and then sell the stock soon after it starts trading on the open market.

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3) When the bear market is coming to an end: A bear market can be the best time for investors to pick up profitable stocks.

4) When there is a widespread panic-selling in equity markets: Panic-selling occurs when investors rush to sell their shares in a panic. This will often create some excellent buying opportunities for well-informed traders and investors.

Some Stock Market Terminologies

Bear Market: This is trading talk for the stock market being in a down-trend, or a period of falling stock prices. This is the opposite of a bull market.

Bull Market: This is when the stock market as a whole is in a protracted period of increasing stock prices.

Beta: A measurement of the relationship between the price of a stock and the movement of the whole market. If stock XYZ has a beta of 1.5, it means that for every 1 point move in the market stock XYZ moves 1.5 points and vice versa.

Blue Chip Stocks: These are the large, industry-leading companies. They offer a stable record of significant dividend payments and have a reputation of sound fiscal management.

Index: An index is a benchmark which is used as a reference marker for traders and portfolio managers. A 10% index may sound good, but if the market index returned 12% then you didn’t do very well since you could have just invested in an index fund and saved time by not trading frequently. Examples are the Dow Jones Industrial Average and Standard & Poor’s 500.

Spread: This is the difference between the bid and the ask prices of a stock, or the amount someone is willing to buy it at and someone is willing to sell it at.

Stock Symbol: A one-character to three-character alphabetic root symbol which represents a publically traded company on a stock exchange. Apple’s stock symbol is AAPL.

Volatility: This refers to the price movements of a stock or the stock market as a whole. Highly volatile stocks are ones with extreme daily up and down movements and wide intraday trading ranges. This is often common with stocks that are thinly traded, or have low trading volumes. This is also common with the stocks that Tim trades.

Volume: The number of shares of stock traded during a particular time period, normally measured in average daily trading volume.

Yield: This usually refers to the measure of return on an investment that is received from the payment of a dividend. This is determined by dividing the annual dividend amount by the price paid for the stock. If you bought stock XYZ for GH₵40 per share and it pays a GH₵1.00 per year dividend, you have a ‘yield’ of 2.5%. 

 

 

ABOUT OMEGA CAPITAL

Omega Capital Limited is an Investment management, private equity and investment advisory firm. The Company is authorised and regulated by the Securities and Exchange Commission of Ghana.

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Analysts:

Nana Kumapremereh Nketiah (JP)

Moses Osei-Yeboah

Omega Capital Research

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Disclaimer

Additional information is available upon request. Information has been obtained from sources believed to be reliable but Omega Capital Limited (“Omega Capital” or “The Firm”) does not warrant its completeness, accuracy or veracity. The firm is licenced and regulated by the Securities and Exchange Commission of Ghana (SEC). This material is for information purposes only and it is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and estimates herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information.

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