Investing Basics
Owning a share means owning a claim on what a business earns later
A price on a screen is easier to watch than the thing it refers to, which is a fractional stake in the future earnings of an actual enterprise.
By Varun Krishnan3 min read
The certificate and the business
A share is a unit of ownership in a company. Holding one confers a fractional claim on what the enterprise owns and, more importantly, on what it earns from here onwards — some of which may be paid out and some retained and reinvested on the owners’ behalf. That is the entire substance of the instrument.
The price quoted for that share is a separate thing: it is the amount at which somebody was willing to buy and somebody willing to sell at a particular moment. It refers to the underlying claim, and over long periods it tends to follow it, but on any given day it is a fact about the market rather than about the business.
Holding both ideas at once is the useful skill. The price is real and it is what you can transact at. It is not the same as the value of what you own.
Why prices move more than businesses do
The earnings of a large established enterprise change gradually. The price of its shares changes constantly, sometimes by several per cent in a day, and the difference is not because the business was reassessed that morning. Prices incorporate expectations about a long future, and small revisions to expectations about many distant years produce large movements in a present figure.
They also incorporate what buyers and sellers happen to want at that moment: liquidity needs, changes in sentiment, and views about other assets entirely. A share price is a negotiated number, and negotiated numbers move for reasons unrelated to the object being negotiated over.
This is the mechanical reason volatility exceeds the volatility of the underlying activity. It is not evidence that markets are irrational, and it is not evidence that they are efficient either — that argument is long-running and unresolved.
What a valuation ratio is trying to say
Comparing a price against something about the business — earnings, assets, sales — produces the ratios investors quote. The most common compares price to earnings, and its plain meaning is how many years of current earnings the price represents, which is a rough way of asking how much optimism is embedded in it.
Take invented figures for illustration. If a share costs 40 and the business earns 2 per share, the ratio is 20. That says nothing on its own; whether it is high or low depends on how fast earnings are expected to grow, how reliable they are, and what the alternatives offer. A high ratio can be entirely justified and a low one can be a warning rather than a bargain.
The ratios are a language for discussing expectations rather than a measurement of value. They compress a great deal into one number and lose most of the detail in the process.
A fund holds the same claims in bundles
Most households that own shares own them through funds, which changes the packaging rather than the substance. A fund holding hundreds of companies is holding hundreds of fractional claims on future earnings, and its value moves with the aggregate of them.
That bundling removes the need to assess any individual business, which is the main reason it exists. It also removes the possibility of a single company failing and taking a large share of the money with it — the specific risk that diversification addresses.
What it cannot do is separate the holder from the fortunes of businesses in general, because that is the thing being owned. A broad fund is a claim on a very wide set of future earnings, and if those earnings disappoint collectively, it falls.
Why the framing changes behaviour
Thinking of a holding as a claim on future earnings rather than as a number that moves has one practical effect, which is that a falling price becomes a question rather than an event. Has what the business is expected to earn changed, or has the price changed? Those have different implications, and only the first is information about the asset.
It also makes the horizon meaningful. A claim on decades of future earnings is not sensibly assessed over months, and the mismatch between how long the claim runs and how often the price is checked is the source of a good deal of unnecessary anxiety.
None of this indicates what anyone should hold. Individual companies carry risks that broad holdings do not, valuation is genuinely difficult, and circumstances vary — which is why a decision of any size is worth taking to a regulated adviser rather than settling from a general description of what a share is.
Common questions
Why does a share price move when nothing has happened to the company?
Because the price reflects expectations about a long future and the willingness of buyers and sellers at that moment, not a fresh assessment of the business each day. Small revisions to distant expectations, and shifts in what participants want to hold, both move prices without anything changing at the enterprise.
Is a low price-to-earnings ratio a sign of a bargain?
Not by itself. A low ratio can reflect genuine doubts about whether current earnings will continue, and a high one can be justified by growth that does arrive. The ratio summarises expectations rather than measuring value, and it needs the context of the business and its alternatives.
Do I own part of a company if I hold it through a fund?
The fund holds the shares and you hold a stake in the fund, so the exposure to those businesses is real while the direct legal ownership sits with the fund. The practical effect is the same claim on future earnings, spread across many companies at once.
Varun writes the explanatory pieces on spending, saving, debt and would rather show the working than assert the conclusion.
