What is a share?

Typically the answer to the question "what is a share?" runs along the lines of "a share is part ownership in a company". This definition is almost entirely unhelpful because it does not explain what ownership means.

If you own an ipod you can download music to it, you can listen to it, you can put a cover on it, you can stick it in a blender and turn it into dust like in that YouTube video, but you can do none of these things to a share.

The best definition of ownership that I have come across is that ownership is a bundle of rights. The rights associated with a share are quite limited. From what I can tell these are the rights available to shareholders:

- you can sell your shares
- you are entitled to dividends in proportion to the number of shares you own, that is, the cents per share paid as dividends will be the same for your shares as for everybody elses (unless there are different classes of shares with different rights, in which case, all shares in a class will receive the same dividends)
- you have the right to attend and vote at the annual general meeting (which, if you work full-time, you will be unlikely to be able to attend)

This does not look like ownership of a company to me. This looks like ownership of a financial instrument and the point of a financial instrument is to move money around from where it is not needed to where it is needed so that everyone benefits.

Why is this important?

It is important because it has a bearing on how you value a company and if you don't value a company you can't tell whether you are paying too much for the shares or not.

If you take the view that a share is part ownership of a company then you would value the company by forecasting its earnings, discounting them to present value (see note below) and dividing by the number of shares. If you take the view that a share gives you the right to receive dividends, you would deduct the proportion of earnings that will be retained by the company from the earnings to determine the dividends then discount the dividends to present value. This adds an extra element of risk, which means you would use a higher discount rate, which would give a lower value.

Why am I thinking about this now?

I am thinking about this now because Graham and Dodd point out the existence of the conflict between ownership of a financial instrument vs part ownership of a company in Chapter 29 of Security Analysis. They only mention it in passing before going on to look at dividends in detail, but I needed to get my thoughts straight.


A note on discounting

Discounting can be thought of as the opposite of earning interest. If you have $1,000 and you put it in a term deposit at 5% interest, in a year's time it will be worth $1,050. So the present value is $1,000 and the future value is $1,050. If you were saving for something that costs $1,050 and you wanted to buy it in a years time, you would 'discount' the $1,050 by 5% to find out how much you had to put in the term deposit now to have $1,050 in a years time.

In the case of a bank account, it is fairly straight forward because you know the interest rate. In the case of shares you have to work out for yourself what dividends you think you will recieve in future and what level of return you want to compensate you for investing in the shares and taking the risk of not recieving those dividends either at that level or at all. This amount should be higher than what you can recieve by putting money in the bank because you can be fairly confident that you will be paid the interest by the bank and be able to get your principal back.