You would be forgiven for believing that buying shares is a get-rich-quick scheme. In recent years in Malawi shares have been heavily underpriced when they’re brought to market in an initial public offering (IPO); this means that there have been more people wanting to buy shares than there are shares available.

What happens when demand is so high relative to supply?

If a company wants to have 100,000 shares listed on the Malawi Stock Exchange they would offer them at a fixed price. If they receive demand for more shares than this the price will stay the same and the number of shares also stays the same so some people don't get any or get less than what they want.

Note that if there is a "greenshoe option" in the share offering documentation then they can issue up to 20% more shares but they cannot change the price once orders are being received.

Once the offering is closed the shares become available to buy and sell on the open market. Those people that didn't get as many shares as they wanted are free to buy from those that did. What's the result of this? An increase in share price.

Basic economics dictates that when demand rises, prices rise. So after a share offering that has been underpriced it is not uncommon to see the price shoot up. I heard of one woman in Malawi borrowing money to buy shares in an IPO and then selling them within a week with enough profit to buy a car AND repay the lender!

By the same token, however, once the initial buying and selling frenzy is over the share price settles down to an equilibrium price. Once the share price reaches this level it can stay there for a prolonged period of time because, for the most part, the share dealing market in Malawi turns over very low volumes.

If you bought when the market was high you may have to hold onto a loss position for a long time.

Secondly, shares may come down in price because a large shareholder decides to sell. For instance when the Malawian economy is doing badly large international shareholders cut their losses by selling their entire portfolio.

What should you do if you're in a loss-making same position?

1. If you don't need the money desperately, hold onto the position until the shares move up in price. The Malawi Stock Exchange can email daily or weekly updates to you so you can keep up to date with pricing.

2. If you think the company is definitely on its way to financial ruin, cut your losses and sell. It's better to recover some of your money than to lose all of it.

When you’ve been holding a losing stock for a while the temptation to sell very high but try to be as rational as possible. I bought Apple Inc. shares at $78 in 2006; in late 2008 / early 2009 the share took a beating and was treading well below previous highs of $200. I decided that the I’d sell as soon as the stock price hit 280 and that’s what I did feeling very proud that I had more than trebled my money since 2006 – I have lived to regret the decision ever since: the share price continued its upward streak for years and traded as high as 700 in late 2012!

"When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever." Warren Buffet

Have you been wanting to buy shares but haven’t done so because you want to have a better understanding of how they work? Then this article is written just for you: A share is a unit of ownership in a company.

When a company lists on the Malawi Stock Exchange (MSEX) they offer the market a fixed number of shares at a given price.

People who want to buy the shares submit their firm interest by stating how many shares they want to buy and providing a cheque to that value.

Example:

If Mandasi Okoma Ltd decided to list 100, 000 shares at a value MWK500 each it would mean the company is valued at MWK50,000,000 (100,000 x MWK500).

If you wanted a 0.1% ownership in the company you would buy 100 shares for MWK50,000 (100,000 shares x 0.1% x MWK500). You are now one of the owners of the company. So, how do you make money? There are two ways.

Dividend Income

Firstly, periodically the company shares some of its profits with its shareholders via the payment of a dividend. When you work, you earn a salary; when you lend, you earn interest; when you buy shares, you earn a dividend.

This then becomes an (additional) source of income for you. Some retired people in the developed world with large, well-diversified portfolios live primarily off dividends with no need for another source of income. Wouldn’t that be nice?

Capital Growth

Secondly, you get capital growth. What does this mean?

If the company you have invested in does well, that is, it grows its customer base and starts to earn more revenue then it becomes more valuable.

In the above example the company starts off with a value of MWK500 per share. If the value increases over a period of time to say, MWK600 per share, then your MWK50,000 investment becomes worth MWK60,000. You make a profit of MWK10,000.

What are some of the issues you might encounter in dealing shares?

1. You don't get allocated as many shares as you want.

If there are more people wanting to buy shares than the number of shares available then you might not get any shares at all or you'll get allocated less than what you tendered for. The company selling 100,000 shares may get payments equivalent to 200,000 shares. We say the share offering is “oversubscribed” to define this situation of excess demand. In that case, the company’s investment bankers might give everyone half of what they asked for. However, that’s not usually how it works.

If the share offering is "oversubscribed" those that want a small amount will normally get all they ask for and big tickets will get cut by a large amount.

Why does this make sense?

Large shareholders carry a lot of power: they have more influence on corporate policy and if they decide to sell their holding all in one go, they would cause the share price to fall by a large amount. No company wants this, they would rather have many small shareholders than a few large ones.

2. Share prices can go down as well as up.

This is probably the biggest problem you'll face. When you buy shares and become a part owner in a company you can lose all your money. If something goes wrong lenders, such as banks, are paid back first and if there's nothing left to pay the shareholders then so be it. We'll discuss this in more detail next week.

"Rule No. 1: never lose money; rule No. 2: don't forget rule No. 1." Warren Buffett