Money: Bank on equities to conquer inflation

A BEGINNER'S GUIDE TO; INVESTING IN SHARES: The stock market can be risky, but it is a proven long-term winner, writes Magnus Grimond

The stock market should be a home for at least a part of everyone's savings. Shares have proved themselves one of the few long-term winners in the battle against inflation, enemy number one for long-term savers. But what are shares and why do they do so well?

Quite simply, an ordinary share is a scrap of paper or, nowadays, an entry on a computer disk that represents the ownership of a tiny part of a company. Just how tiny is illustrated by British Telecom's share register. Around 1 million small shareholders with holdings worth less than around pounds 1,800 own an average of 220 shares each, stakes that represent just one three millionth of a single per cent of this huge company.

The point though is not how many shares or how much of a company you own as what each share represents. Take BT. With your share comes "ownership" of a fraction of the profits after tax (32.8p last year) and a stake in the assets of the company (pounds 2.42 at the last count). The stock market puts a lot of faith in earnings and they do reflect the value of the company. If earnings are rising, the company is growing and can pay out bigger dividends to shareholders. It also becomes more attractive to a bidder willing to stump up enough money to buy the whole company and grab those profits. As a result, the share price tends to move upwards in line with earnings or, more importantly, in line with how fast future earnings are expected to grow.

There are two ways of getting your hands on this value: through dividends or by selling the shares. The annual dividend represents two payments for most companies, the interim dividend paid after the middle of its financial year and the final dividend declared when the results for the whole year are announced. Add the two together and you get the total dividend for the year. To obtain a direct comparison with other forms of investment like building society accounts or gilts (government bonds) you need to do a further calculation. Adding back the (20 per cent) tax that the company pays on your behalf before you receive a dividend ("advance corporation tax") and dividing the answer by the share price and will give a "yield" figure.

A quick glance at the shares page of any newspaper shows that the average share is yielding around 3.1 per cent, or well under half what a decent instant access account would pay in annual interest. But that is less than half the story. As well as the fact that this dividend should grow the rest of the shareholder's return comes through the rise (or fall) in the price of his shares. Last year, for instance, the typical share returned just over 12 per cent, of which only a little more than a third came from dividends. Since the beginning of 1997 the market has climbed a further 23 per cent, which is probably a signal for the cautious investor to lock in those gains by selling all or some of his shares. But is that the wise course?

The answer is that it depends on your outlook. For stock market aficionados, the world is divided between bulls (optimists) and bears (purveyors of gloom). For the last 15 or 16 years, apart from one or two short spells, the bears have remained firmly in their caves. Since 1981, the London market has grown fat on one of the longest bull markets of this century. But the bears have long memories. With the tenth anniversary of the 1987 crash now just a week away, many are nervous that the peaks being scaled are unsustainable.

But even if there is another crash history still suggests that shares should provide the best long-term shelter from inflation for your savings. Why? Well through that direct link with a company's profits a share represents an investor's own tiny stake in the economy. All other things being equal, the average company's profits will grow in line with the growth of the whole economy, typically around 2 per cent a year after inflation. By contrast, the fixed or interest rate-related returns from building society deposits and gilts have been eroded by inflation over the past 50 years or so.

Of course, some companies' profits grow faster than the economy, some slower and some go bust. Shares clearly carry more dangers. This means investors look for a bigger return to compensate for the extra risk. This "risk premium" varies widely, but has recently averaged around 6 per cent a year more than the return from cash.

Start your day with The Independent, sign up for daily news emails
Ben Little, right, is a Labour supporter while Jonathan Rogers supports the Green Party
general election 2015
The 91st Hakone Ekiden Qualifier at Showa Kinen Park, Tokyo, 2014
Life and Style
Former helicopter pilot Major Tim Peake will become the first UK astronaut in space for over 20 years
food + drinkNothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
Kim Wilde began gardening in the 1990s when she moved to the countryside
peopleThe singer is leading an appeal for the charity Thrive, which uses the therapy of horticulture
Alexis Sanchez celebrates scoring a second for Arsenal against Reading
Life and Style
An easy-peel potato; Dave Hax has come up with an ingenious method in food preparation
voicesDave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
Japan's population is projected to fall dramatically in the next 50 years (Wikimedia)
Life and Style
Buyers of secondhand cars are searching out shades last seen in cop show ‘The Sweeney’
motoringFlares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £45,000: SThree: SThree Group have been well e...

Ashdown Group: IT Manager / Development Manager - NW London - £58k + 15% bonus

£50000 - £667000 per annum + excellent benefits : Ashdown Group: IT Manager / ...

Recruitment Genius: Sales Consultant / Telemarketer - OTE £20,000

£13000 - £20000 per annum: Recruitment Genius: Scotland's leading life insuran...

Ashdown Group: Training Programme Manager - City, London

£40000 - £45000 per annum + benefits : Ashdown Group: Training Programme Manag...

Day In a Page

NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders
Heston Blumenthal to cook up a spice odyssey for British astronaut manning the International Space Station

UK's Major Tum to blast off on a spice odyssey

Nothing but the best for British astronaut as chef Heston Blumenthal cooks up his rations
John Harrison's 'longitude' clock sets new record - 300 years on

‘Longitude’ clock sets new record - 300 years on

Greenwich horologists celebrate as it keeps to within a second of real time over a 100-day test
Fears in the US of being outgunned in the vital propaganda wars by Russia, China - and even Isis - have prompted a rethink on overseas broadcasters

Let the propaganda wars begin - again

'Accurate, objective, comprehensive': that was Voice of America's creed, but now its masters want it to promote US policy, reports Rupert Cornwell
Why Japan's incredible long-distance runners will never win the London Marathon

Japan's incredible long-distance runners

Every year, Japanese long-distance runners post some of the world's fastest times – yet, come next weekend, not a single elite competitor from the country will be at the London Marathon
Why does Tom Drury remain the greatest writer you've never heard of?

Tom Drury: The quiet American

His debut was considered one of the finest novels of the past 50 years, and he is every bit the equal of his contemporaries, Jonathan Franzen, Dave Eggers and David Foster Wallace
You should judge a person by how they peel a potato

You should judge a person by how they peel a potato

Dave Hax's domestic tips are reminiscent of George Orwell's tea routine. The world might need revolution, but we like to sweat the small stuff, says DJ Taylor
Beige is back: The drab car colours of the 1970s are proving popular again

Beige to the future

Flares and flounce are back on catwalks but a revival in ’70s car paintjobs was a stack-heeled step too far – until now
Bill Granger recipes: Our chef's dishes highlight the delicate essence of fresh cheeses

Bill Granger cooks with fresh cheeses

More delicate on the palate, milder, fresh cheeses can also be kinder to the waistline
Aston Villa vs Liverpool: 'This FA Cup run has been wonderful,' says veteran Shay Given

Shay Given: 'This FA Cup run has been wonderful'

The Villa keeper has been overlooked for a long time and has unhappy memories of the national stadium – but he is savouring his chance to play at Wembley
Timeless drama of Championship race in league of its own - Michael Calvin

Michael Calvin's Last Word

Timeless drama of Championship race in league of its own