The Simplest Way To Understand Stock Investing

Investing in a company’s stock is not the same as lending your money to the company. What exactly is the difference between the two? When companies are short of cash, they can issue bonds or notes to borrow money from the public. The company borrowing the money pledges to repay the amount borrowed after a certain period of time plus interest on top of it. The interest is the profit of those who gave their money to the company in the form of debt to fund its operations. The point to note here is that when you lend you money to a company, the company must repay the debt when it’s due.

When it comes to investing a company’s stock or shares, you become an owner in the company. In that case, you share the company’s profits and losses. Because of this, a stock investor needs to do enough due diligence avoid investing in companies that won’t generate the required returns.
Companies listed on the Nairobi Securities Exchange (NSE) regularly publish their financial statements so that existing investors and potential ones can know how they are performing. When a company is profitable, you see that the demand for their shares increases, resulting in the appreciation of the share price. When the shares have significantly risen above the price you paid to acquire them, you can choose to sell your shares in the company for a profit.

Some profitable companies also distribute excess cash to shareholders in the form of dividends. These dividends can be paid out on a monthly, quarterly or annual basis depending on what the management and the board of the company deem fit for shareholders.   Therefore, on top of the appreciation in the stock price, shareholders in a company also benefit from dividend distribution.

Take the example of Safaricom Ltd (NSE:SCOM). During its 2008 IPO, a share of Safaricom was sold for Sh5. Today, the shares are trading in the vicinity of Sh17. Safaricom also pays dividends to its shareholders. For its FY2016, the company declared that it would distribute more than Sh30 billion in dividends to its shareholders, which translates to Sh0.76 per share. To put that in perspective, if you owned 100,000 shares in Safaricom, your dividend income would be Sh76,000.  That is on top of the nearly Sh12 profit per share if you consider the stock’s prevailing price of about Sh17 and the IPO price of Sh5. Something to note with Safaricom is that the demand for the company’s stock was so high during the IPO that investors were unable to acquire as many shares as they wanted.

When the shoe is on the other foot
When a company is making losses from its operations, many investors tend to lose appetite for its shares, thus causing the stock price to fall. In that case, when the price of the stock falls below the cost you paid to acquire them, you end up losing money in your investment. For example, if Safaricom offered its shares at Sh5 during the IPO and the shares were trading at Sh2 today, it would mean a loss of Sh3 per share for every investor who acquired the shares at the IPO.

Additionally, loss-making companies typically don’t pay dividends because they try to maximize the little resources they have to remain in business. Therefore, if you are an investor in such a company, you lose your investment and there are no dividends to offset the losses.


What’s the secret of winning in the stock market?
There is no single strategy that works for all stock investors in a market. But what is common among smart investors is that they try to remain on top of the news so that they are aware of developments that could affect the performance of their stocks.