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Market Value And Growth
One might think from this that a shareholder could sell a share in a company such as that just mentioned for £2 on the market. Although this could be so it is not necessarily so. The price of any share in the market is determined by the actions of buyers and sellers on the Stock Exchange, and most people buy industrial shares not because of their underlying asset value, but for what the shares represent in terms of a flow of income by way of future dividends, and of capital growth (i.e. future rises in market price of the shares).
So the market price of a share reflects many factors:
(a) the rate of current dividend distribution;
(b) the anticipated future distribution;
(c) the anticipated trend in pre-tax profits;
(d) the policy of the company in retaining and distributing
profits;
(e) the state of the company's balance sheet.
Factors (c) and (d) determine a sixth factor, the prospect for the future of further growth in the net asset value of the shares; and factors (a), (b) and (c) determine a seventh factor, the anticipated future response in the market to that growth. In other words, a widespread belief that the share price will rise will itself create a rise in price.
In general, therefore, company dividends alone represent a fairly low yield expressed as a percentage of the price of the share, since what the investor hopes to obtain from his holding is not so much current income as growth over the longer term. There was a time when the dividend yield on equities was significantly higher than the running yield on gilts; and this was what was then expected, for the ordinary shareholder was risking his money in a business venture whereas the buyer of gilts was merely lending money to the government. But today (2000), with inflation at around 20% and the world economy in recession, industrial profits are not easily earned and the dividend yield on ordinaries is, on average, well below the yield on gilts.
So why do people buy equities? The main urge to do so comes from the belief - which may by perfectly well founded - that over the very long term industry will again become very profitable. When it does so the value or price of shares might well rise by far more than would be needed merely to compensate the holder for his meagre dividends.
Equities
The first possibility is to buy ordinary shares of companies - often referred to as 'equities'. These are literally a share in the ownership of companies in the private sector, and are essentially risk capital. The companies make no guarantee to pay dividends on the shares, and there is no certainty that a shareholder will get his capital back. Were the company to lose all its capital, for example, through trading at a loss, through bad management, or from the uncertainties of a changing market for its product, the shares could become practically worthless, and would certainly pay no dividend.