Chapter: 5 Investing in Stocks

Section: 2 Why Invest in Stocks?

There are many alternative avenues of investments open to an individual, to name a few: saving accounts, certificates of deposits, commercial investments, government bonds, stocks etc. Each of these has varying investment characteristics and a different risk return trade-off. The following comparison helps to understand the risk and return profile of some of the selected investment options.

 

A comparison of alternative investment opportunities:

 

 

* Return from shares would depend on the performance of the company; it may lead to a capital loss as well.

** Return from shares would depend on the performance of the company; it may lead to a capital loss as well.

The main features that make investment in stocks attractive include:

 

i) Unlimited Up Side Potential: Shareholders own a part of the assets of the company and part of the stream of cash generated by those assets. As the company generates more and more profit, the value of the business increases and thus the share price rises in the market. This growth potential is not limited by any ceiling.  A good example, for instance, is the public listing of Saudi Telecommunications Company (STC) on the stock market. Offered to investors at a price of SR170, the stock opened at SR212 and reached SR330 by the end of the first trading day on January 25, 2003. By June 30, 2004 it had appreciated to SR380.

 

Other modes of investments offer a specified return. For instance, one can earn 3%per annum on a savings account, a five year maturity government bond can yield 5%, to name a few.

 

ii) Liquidity: Shareholders of public companies can liquidate their shares any time they want by selling them off in the market. In other words, there is ready market for listed shares. However, in the process, the investor may make a gain or loss on its investment and pay the transaction costs. Also, the degree of liquidity varies among shares and normally blue chip stocks (shares of large corporations) are more liquid.

 

iii) Control/Ownership: The shareholders are the true owners of the company. Major shareholders can control the company through the directors who are appointed by them. Shareholders have the primary right for the appointment of directors of their choice. The board of directors basically directs the company affairs.

 

iv) Regular Income: Shareholders may receive a certain percentage of the profit earned by the company during the year as dividend. Some companies pursue a constant dividend policy, whereby every year an agreed percentage of profits earned are paid out as dividend to its shareholders.

 

However, having cited the advantages, it should be noted that shareholders take the risk of losing the entire capital they have invested in the business when things go wrong. When a company is liquidated, the shareholders are the last party to get a settlement if anything remains after paying off all the corporate dues and debts.