If you are not too familiar with the investing world and have often heard about shares or stocks or the stock market, wondering what they could mean. This article would give you an insight into the world of stock. For starters, a stock is a type of investment that grants investors partial ownership in a company.
Definition of Stock
A stock is a type of security that represents part ownership in a corporation. It can also be said to be the total shares into which ownership of a company is divided. Collectively, shares are known as stock, and one share of a stock represents part ownership of a company in proportion to the total number of shares. Stocks form the core of almost every portfolio.
According to Investopedia, “a stock is a type of security that signifies proportionate ownership in the issuing corporation.”
Companies can issue (sell) stocks by getting publicly listed on a stock exchange; that way, public investors would have access to shares of the company in proportions. Stock exchanges are the primary platform for buying and selling stocks publicly. Although, private trades still occur in many corporations. Stock exchanges help govern and regulate the activities of the stock market by protecting both the interest of the buyer and seller, preventing fraudulent activities. Compared to other investments, stocks have outperformed the investment market over time.
What are Shares?
According to Wikipedia, “shares represent a fraction of ownership in a business.” The shares of a company form the stock. In other words, the stock of a corporation can be divided into shares.
As earlier stated, corporations issue or sell their stock by getting listed on a stock exchange as a public company. The major reason why corporations issue stock is to raise funds for their businesses in return for part ownership in the corporation. A private company may decide to go public for the purpose of reducing their holding and freeing up capital for their private use. They can achieve this by getting listed as a public company on any of the stock exchanges and make an offer to public investors through an initial public offering (IPO).
People who buy stocks of a corporation are called shareholders. By purchasing a stock of a corporation, the holder has bought fractional ownership rights in the corporation. The type of shares held would determine whether or not the holder will have a claim to part of the corporation’s assets and earnings.
A shareholder’s ownership is determined by the number of shares the holder owns in proportion to the number of outstanding shares. Simply put, the number of shares you own in a corporation would be proportionate to the percentage of your ownership in that company. For example, if a company has 2,000 shares of stock outstanding and you purchase only 100 shares, you would be entitled to only 5% ownership and claim of the company’s assets and earnings.
Ownership in a company through stock does not mean that the shareholder “owns” the corporation; rather, it means that the shareholders own shares issued (sold) by the corporation. For example, if a shareholder holds as much as 30% shares of a company, it would be incorrect to assume that the shareholder owns a third of the company’s assets, rather, the shareholder owns a third of the company’s shares. This is quite similar to acquiring or purchasing a new company. The acquiring company doesn’t literally buy the assets of the other company, rather it buys up all the shares of the company. Unless in a few cases like a total buyout.
A person may own 50% of shares in a company, however, this doesn’t mean that the person owns 50% ownership of a company. Because a corporation is considered a legal person, it owns all its assets. As a result of that, a shareholder who owns 50% of shares does not have the legal right to use a company’s equipment, material, building, or any other property. This is called separation of ownership and control.
The shareholder’s ownership is determined by how much shares the corporation makes available to them. However, there are other privileges and benefits given to shareholders by the corporation. Depending on the type of stock owned, you may have the right to vote in shareholder meetings. Majority shareholders have more voting power compared to other minority holders. As a majority shareholder, you can indirectly use your increased voting power to indirectly influence the selection and appointing of a new board of directors in a company. There are also dividends (company profits) that are distributed amongst holders. You have the liberty to sell your shares to someone else and make a profit.
As regards making voting rights and influencing certain decisions in a company, ordinary investors are barely concerned with all of these as long as decisions made are in favor of all the shareholders. For many ordinary shareholders, the main idea of purchasing a company’s stocks is not to partake in the management of the business but to be entitled to a portion of the company’s profits. Of course, the number of shares you own is proportionate to the dividends you will receive. It is important to note that, not all stocks pay out dividends, instead, the dividends are reinvested in the company to increase its value.
Ownership in a corporation does not necessarily mean that all shareholders would have the leverage of directly making decisions in the company. Considering that a company may have thousands of investors and it would be illogical to take in thousands of decisions on a daily basis. Instead, through their shares, holders are able to vote in the election of new board members they believe are capable of running the affairs of the company with the best interest of the shareholders at heart.
Though the shareholders do not directly have a say in the management of a company, they still have a level of impact on the policy of the company through the elected board of directors. The candidates are usually nominated by company insiders. If the shareholder perceives that the board is not performing well they can select or elect a new board to handle the affairs of the company.
Note: As a shareholder, you do not share liability responsibilities. If a company goes bankrupt and has to default on loans, you are not liable in any way. However, when the company is liquidated all outstanding debts would first be paid off to the creditors before the shareholders can receive any money. Whatever is left from debt payments would be distributed among shareholders, first preferred shareholders then common shareholders.
Types of Stocks
There are two major types of stocks, namely: common stock and preferred stock.
Common Stock: This type of stock entitles the owners voting rights at shareholders’ meetings. Shareholders are also entitled to receive dividend payouts by the corporation. On the contrary, not all companies pay shareholders dividends and those that pay do not have a fixed amount.
Preferred Stock: This type of stock does not give shareholders voting rights, however, the shareholders are entitled to higher claims on assets and earnings. They also receive dividends before common shareholders and more priority is placed on them in the event of a company going bankrupt and is liquidated. The dividends paid to preferred shareholders are fixed, therefore, the shareholders are able to calculate their annual dividends ahead of time. Also, excess cash distribution goes first to preferred shareholders before common shareholders.
Investing in Stocks
To start with, every investment involves risks, some with more intensity than others. Investing in stocks is riskier than other types of investments. Nevertheless, stocks have better potentials of bringing investors more returns. There are two main ways stock investors earn money, by either selling their stocks or dividend payments.
Investors have the liberty of selling their shares at any time. The idea behind selling stocks is that when the price of a stock goes up throughout the time it is in the possession of the holder, the holder can sell it more than what they got it for—at a profit. Whereas in dividend distributions, only common shareholders are paid on a quarterly basis. Preferred shareholders do not receive dividend payments.
On the stock exchanges, stock prices fluctuate all through the day and investors must follow the price movements to know when to hold, buy, or sell. They do this in hope that the stock prices would appreciate in value over time so they can make good returns. On the contrary, while every stock investor expects that a stock would increase in value over time, not all stocks perform well. The performance of a stock is dependent on the performance of a company such that if a company goes bankrupt or out of business, its stock will lose value. If that happens, the investor stands to lose some or all of their investment. To avoid such unfortunate events, it is advisable for investors to buy stocks across multiple companies and diversify their portfolio with other stock-related investments. Rather than focus their investment on just one company.
Investing in individual stocks takes a longer time. Some investors would rather invest in index funds, mutual funds, or ETFs to save time. By doing so, investors can purchase multiple stocks in a single transaction. This opens them up to automatic portfolio diversification.
The distinguishing factor between long term and short term investors is their level of risk tolerance. Most times, investors who benefit more from the stock market are those that buy and hold over the long term. In most cases, these investors diversify a portfolio of many stocks and hold them for a long time—a decade or more. During which the stock market may suffer some of its worst moments and experience some of its best moments.
Where can I purchase stocks from? Stocks can mostly be purchased from online stock brokers. You would have to open a brokerage account with your preferred online broker. The process is quite similar to opening a bank account. These online brokers also charge commissions for trading stocks. Nevertheless, the commissions differ by the broker.
How to make money in the stock market
One of the best ways to become rich and wealthy is by investing in the stock market. It appears easy but it's not. Investing takes patience, good timing, cash, and good research. The first step is to find out what stock you want to invest in. You can check out stock prices and company histories by doing a simple search on Investingport.com.
The second step, buy the stock after you have done your due diligence, and if the price of the stock goes up while you own it, you make money. But if the price goes down while you own the stock, you have lost money.
Another way to make money in the stock market is by investing in stocks that pay dividends. Some companies engage in profit sharing via dividend payouts. The investors can choose to receive the dividend payment in cash or some can have it reinvested directly so they can own more shares of the company.
A stock derivative is a financial instrument by which the underlying security is the price of an equity. The underlying security can either be a stock index or a firm’s stock. There are two main types of stock derivatives, namely:
Stock Futures; these are contracts by which the buyer is long, that is, taking up the obligation to buy on the maturity date of the contract. While the seller is short, that is, taking up an obligation to sell. This is generally done by cash settlement.
Stock Options; a stock option is a class of options. A put option is the right ‘not obligation’ to sell stock at a fixed price in the future, compared to a call option. The value of a stock option is bound to change in reaction to the underlying stock of which it derivate.