Martha Myron

What it means to own a company’s shares

This is the sixth and final article in a series published between October 1 and 6 in support of the Bermuda Stock Exchange World Investor Week Quiz Challenge. Each article has a question embedded. Find the question and send your answer to wiwqc@bsx.com. Those with six correct answers will be entered into a draw to win a grand prize of a $2,500 Bermuda securities portfolio.

A year ago, Moneywise featured an article focused on “Reasons for investing in Bermuda stocks”. It looked at why should you invest; what can it do for you as a personal investor (no matter how small your investment portfolio size); and how investing in Bermuda public companies contributes to the overall economic success of Bermuda’s businesses.

This year, we review the evolution of stocks from idea to incorporation to issuing stock ownership. That includes what makes a stock what it is, where do profits enter into the equation, how stock can appreciate in value, the receipt of dividends (or not), and why stocks are traded on public exchanges.

Be aware that these are just basic concepts, not for you investing sophisticates. We are not including operations of the company, products, employee, and accounting procedures for this missive.

However, I do encourage you to become a beginner investor and have a fascinating time learning about stocks and other securities. Check the links at the end of this article.

Development of a hypothetical company

Ideas! Brilliant ideas — for a new pizza product. A group of six friends begin a start-up using mom’s garage with each person putting up $2,000 to get it operational.

At this juncture, the talented group of chef pals is a loose partnership with little business structure.

Reality dictates, then, that in order to protect each other’s interests along with a host of other legal, tax, insurance, and financial structures, the group of pals needs to incorporate to make their business a legitimate entity. And so it went.

Incorporation

A private Bermuda corporation, by virtue of its legal formation, eg limited by guarantee, will establish stock ownership at $1 per share up to 12,000 shares, where one person, or a number of individuals, contribute cash or valued assets into the corporate till, not necessarily in the same percentage.

Their start-up cash infusions are legally recorded on the brand new company’s articles of incorporation, financial statements, while each shareholder receives 2,000 shares issued by the new corporation for their contributed capital to define company ownership. The individuals are now an equal equity owner in this newly incorporated Bermuda company.

There are great differences between private and public companies. Initially, our chefs have no intention to put their shares or issue more for trading in the public domain.

Company operations

The pizza company started out with 12,000 shares on the books and $12,000 in the bank It hasn’t earned a penny, but the company has value.

A year goes by and the company’s operations are smooth, Sales at Albouy’s Point are great! There is cash coming in, reams of it, and of course cash is going out; you can’t make pizza out of nothing. Each month there is more cash left in bank than at beginning. So far, so good.

Profits, retained earnings, and dividends

End of year accounting arrives. Did they make a profit?

Yes, their profit margin after all expenses are paid is $60,000. On paper their shares are now each worth $5 — a fantastic appreciation in value in one year. The total profit is recorded in the company retained earnings.

In year two, operations are still good and the business earns additional net revenue of $90,000, increasing retained earnings to $150,000. Shares are now worth $12.50 each.

In year three, the same $90,000 of net revenue moves the share value to $20. All the owners realise that their company is appreciating in value faster than, say, putting cash on deposit.

While business is now steady, they need further expansion, such as upgrading machinery, hiring additional employees, paying manager salaries, and advertising. Plus, the owners now want to pull some of the profits out of the business — in other words, the company will pay out some of the profits in the form of dividends.

Remember how the original shares started at one dollar?

The company’s board of directors declares an annual dividend of $3 per share, payable quarterly. Each owner will receive an annual total of $6,000, a nice return on their original investment, plus even though the company retained earnings is reduced by $36,000 to $204,000, each of them owns an equity asset of $34,000. Not bad for a $2,000 investment three years ago.

Give the correct term to describe the strategy of investing the same amount of money at regular intervals over an extended period, regardless of share prices.

IPO launch

Now the friends have ambitious plans to dominate the market and that takes more capital than they currently have.

They do not want to borrow. So, they agree to issue another 28,000 shares at $12 each for sale to the public, meaning that the six chefs will no longer have full ownership of a private company. It will be partially publicly owned. Anyone can purchase these shares, but no one can purchase more than 5 per cent of the issuance.

The company coffers will receive the cash for expansion, along with allowing Bermuda residents the opportunity to own a piece of the rock, have appreciation in stock value in a Bermuda publicly-traded company and the chance each year to receive dividends on the investment.

An initial public offering is a complex sequence of events. Space does not permit further details.

However, once private stock becomes publicly-traded and offered for sale to the public, any shareholder can sell to another individual or entity through a stock exchange. This is trading on the secondary market, on the Bermuda Stock Exchange.

Think of the following companies: Argus, Ascendant, Bermuda Aviation, Bermuda Press, BF&M, LOM, One, Somers, Butterfield Bank, Watlington Waterworks, West Hamilton Holdings, Devonshire Industries and Polaris Holdings.

Most of them started small. You know them. Maybe you work for them, buy from, sell to them, or use their products and services. They are Bermuda public companies and you can own your piece of the rock by becoming a shareholder.

Resources:

• Bermuda Stock Exchange. http://www.bsx.com/index.php

Wall Street Mojo. https://www.wallstreetmojo.com/stocks-vs-shares/

Investopedia. Investing for Beginners. https://tinyurl.com/ybnpfwvz

BEBusinessed. History of the Stock Market. https://bebusinessed.com/history/history-of-the-stock-market/

A Guide to Bermuda Companies: Appleby. https://tinyurl.com/y96nkp8w

Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Dual citizen: Bermudian/US. Pondstraddler Life, financial perspectives for Bermuda islanders and their globally mobile connections on the Great Atlantic Pond. Finance columnist to The Royal Gazette, Bermuda. All proceeds earned from this column go to The Reading Clinic. Contact: martha.myron@gmail.com

• Full details of the BSX WIW Quiz Challenge are in the PDF attached to this web page under the Related Media heading