I ASSETS OR SHARES: WHAT ARE THE DIFFERENCES?

All investors are different. Some run businesses, some are retired, some have a high-risk tolerance, and some don’t. But every investor shares the same fundamental goal: Increase their wealth. Assets and shares can help achieve that goal. What are assets? What are shares? What are the differences between them? What benefits do each have, and what risks do they impose? Answers to these questions will assist individual investors determine whether assets or shares are best for them.

II WHAT IS AN ASSET? WHAT IS A SHARE?

An asset is a good, property, item, or thing that provides value to its owner. In business, there are two types of assets: (1) real assets, which refer to tangible goods used to provide goods or services (for example, real estate or equipment), and (2) financial assets which are used to finance real assets, and include things like debt, cash, and shares.

Real assets are intrinsically valuable. For example, a car is valuable because it functions to transport its owner from place to place. Contrastingly, the value of a financial asset is derived from the value of the real asset it represents. For example, a debt is only as valuable as the principal and interest it represents, and cash is only as valuable as the items it can buy. Regardless, both types of assets are integral to the operation of all businesses.

A share is a claim to a Business’s assets and the value those assets will generate. A person who owns a share is called a shareholder, and a shareholder’s claim to an asset and its future value is divided amongst other shareholder, in proportion to the amount of shares they own. For example, If a company is worth $100 million (i.e. the value of its assets), and one shareholder owns 10% of shares, then that shareholder owns $10 million of the business value. If the business liquidates, the shareholder is entitled to recover (after debtholders, and other creditors) $10 million, if it is available.

III KEY DIFFERENCES BETWEEN ASSETS AND SHARES

(1) Difference in Profit & Expenses

Assets perform a function to create profit. That profit is solely owned by the person who owns the asset, and the owner may use the profit as they choose. If the asset performs as it should, profits can be generated immediately.

Assets usually incur a large upfront purchase cost. Then, assets may incur costs to be monitored, maintained, and operated. For example, an automative repair shop might purchase a car hoist. That machinery enables the shop to work on cars more efficiently, enabling the shop to service more customers and generate a larger profit. However, the machinery will need to be monitored by staff, be regularly maintained, and will need electricity to operate. Each of these costs should be considered by the buyer, as it will impact the profit made.

Shares make profit in two ways: (1) dividends and (2) capital gains. A dividend is an optional payment made by the company to shareholders every six months. New companies do not usually pay a dividend, while legacy companies do. Shareholders make a capital gain when the share’s value increases above the amount they originally purchased the shares for. For example, if a shareholder purchases a share for $10, and the share increases in value over 1 year to $50, the shareholder may sell the share and make a $40 capital gain.

Some trading activities aim to make a quick profit. However, these strategies are extremely risky and can result in losing your entire position. Usually, investors keep shares for decades to receive long term profits.

Shares do not require maintenance like a real asset might. However, fees are usually incurred each time a purchase or sale is made. Additional fees will be incurred if the investor uses an investment company’s’ services.

(2) Difference In Risk

Assets are generally considered less risky than shares. That is because assets are exposed to less volatile risks than shares. However, the following risks are present: (1) assets are at risk of becoming obsolete. New innovations and competitive markets often produce assets that can perform the same process more efficiently, effectively, and with less cost. When an asset becomes obsolete, the initial capital invested is wasted, and additional funds are required to purchase new assets. (2) All assets have a finite lifespan. This means all assets risk breaking down. This risk exposes investors to large maintenance and replacement costs.

Shares are notoriously risky and are exposed to two types of risk: (1) Market risk, and (2) Firm specific risk.

Market risk is the risk that a change in market conditions will decrease the value of your share. Changing market conditions can include things like changes to tax policy, political uncertainty, new regulations, new innovations, and so on. For example, the announcement that interest rates will be reduced usually reduces market risk. This occurs because lowering interest rates gives companies more money to invest in positive cash flow projects, increasing the value of shares in the market.

Firm specific risks are risks that only affect the firm in which you have shares. For example, announcing a reduction in dividends, announcing smaller than expected sales, or the sudden departure of a trusted CEO or executive, each suggest a struggling firm position. This may reduce investor confidence in the firm and reduce the value of your shares.

(3) Ownership and Control

When an investor purchases an asset, that investor owns the asset. The investor is completely entitled to the profits the asset makes, and completely entitled to use the asset in which ever way they decide. The Investor is also completely liable for any pre-existing liabilities attached to the asset. For example, the investor will be liable for any finance owing on the asset and will be responsible for insuring the asset. Because the investor is the legal owner of the asset, creditors can sell the asset to make good on debts the investor has in other areas of their life.

When an investor purchases a share, the seller gives away partial ownership of the company. The shareholder will usually have voting power in proportion to the number of shares they own. However, the day-to-day control of the company resides with the board of directors. The shareholders cannot force the directors to make certain decisions.

Additionally, the shareholder becomes exposed to all the liabilities of the firm. This means that during insolvency, a shareholder’s claim to assets will be liquidated by creditors to pay off company debts. Unlike owners of assets, shareholders are only legally liable to pay the value of their shares. For example, if an investor purchases 100 shares, each valued at $1, then if the company liquidates, creditors can seek $100 from the value of the investor’s shares. The creditors cannot ‘reach into’ the personal assets of the investor, even if the total value of the company’s debt goes unpaid.

IV KEY TAKEAWAYS

An investor who should invest in shares would prefer immediate profits, have a large fund available for the initial purchase cost, and are willing to incur costs to maintain and operate the asset. This investor would prefer to have total decision making powers, and incur all the benefits and liabilities.

Shares are recommended to Investors who have a high-risk tolerance and a long-term vision. Profits may take decades to realise, so this investor should have enough funds in reserve to finance other activities, so that if difficulties arise, they are not reliant on liquidating shares at a capital loss. Additionally, investors who would prefer others to manage day-to-day operations, should invest in shares.