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Introduction
Shareholders of a public limited liability company get returns from their investments from two sources: dividends and sale of their shareholdings. The value of shareholders shareholding is influenced by the performance of the capital market
What is Capital Market?
Capital market, sometimes referred to as long term market, is the part of the financial market which deals in long-term corporate securities as well as procedures for financing long-term investments. The most common corporate securities in this category are common stock, preferred stock, bonds and convertible securities. Through the institutions and intermediaries that make up the capital market, the society’s surplus funds are made available to corporations in need of funds for long-term investments, corporate expansion, development of new product lines etc.
What is share?
A share is a unit of a company’s capital. Bundle or mass of shares is called stock. There are three major classes of a company’s shares. They are: founders shares, ordinary shares or equities, and preferred shares.
Who is a Shareholder?
A shareholder of a company is one who holds or owns units of a company’s capital. As there are categories of shares so there are categories of shareholders — founders, ordinary shareholders or common stockholders, and preferred shareholders.
How Capital Market Impacts Shareholders Return
1. Capital market determines the share value of a public limited liability company. Securities are attractive during boom but holders suffer losses during depression. In boom periods, profits are high, there are more capital gains, it appreciates in value and return on investment is high. During periods of depression, investments are low, and profit margins are reduced.
2. The performance trend of a business shares in the capital market indicates the position of a company. This among other things, informs the decision of contractors, creditors and others in doing business with the company. This will affect the profitability of such company. The dividends companies share to their shareholders are derived from profits made by the business. When no profit is made no dividends will be shared to the common stockholders. Therefore, capital market impacts company’s earnings, and company’s earnings in turn impacts shareholders earnings.
3. When a company’s share value rises the shareholders get more returns, if they sell their shareholding, and when the price is low, they loss money. Shareholders who wish to sell their shareholdings at a time the company’s share is nose diving will be at a loss. For instance, if a shareholder who bought a company’s share at a time the share was $2 per share, sells the share at the time it trading for $3.5, he gets return of +$1.5 ($1.5 profit). But if the prevailing price at the time he sells his share is $1.5 per share, he gets return of -$0.5 ( $0.5 loss).
4. Investors at the stock market often look out for companies that meet or exceed earnings expectations, whose profits margins are high to invest in. This puts a company’s management under pressure to meet and even exceed expected profit. When management beats the expected earnings, shareholders demand that the excess in earnings be paid to them inform of dividend or at least stock buyback, if management intends to retain the excess earnings.
5. When a company management requires fund for business expansion or working capital but could not source the fund in the capital market due to poor performance of its stocks at the stock market or high cost of capital at the capital market, it resorts to retaining the earnings that were supposed to be shared to the shareholders in form of dividend. The retained earnings impact on the returns of the shareholders as the shareholders who need the cash would not be able to get it. It also denies the shareholders opportunity to invest in alternative businesses that can yield returns to them — opportunity cost. Read Impacts of Retained Earnings on Shareholders Investment Decisions.
Conclusion
Capital market performance, among other indicators has positive and negative impacts on shareholders return as much as it impacts company’s profitability. Shareholders get better returns when the capital market performances better.
Related article: Advantages of Having Wide Range of Shareholders in a Company