What is a stock?
If you are new to investing you might be wondering what is a stock or what are stocks?
Stocks are shares that are issued by a company. When you invest in stock, you buy ownership shares in a company.
Each of these shares denotes a part ownership. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say stock, shares, or equity, it all means the same thing.
One reason why companies issue stock is because it gives them the capital, or money, to run and grow their business.
When a company wants to expand, develop new products, hire more people – it needs money. So the best way for companies to do this is by issuing stock shares.
Investors who own stock are referred to as “shareholders” or “stockholders.”
Holding a company’s stock means that you are one of the many owners (shareholders) of a company. As a shareholder, you hope your investment in the company’s stock will rise in value.
Your return on investment, or what you get back in relation to what you put in, depends on the success or failure of that company.
If the company does well and makes money from the products or services it sells, you can expect to benefit from that success.
There are two main ways to make money with stocks:
When investors buy stock they hope the company they invest in will grow and earn money, because the value of their stock will rise in value as the company grows and ultimately when they sell their stock they will have made money. These profits are known as capital gains. In contrast, if you sell your stock for a lower price than you paid to buy it, you’ve incurred a capital loss.
When publicly owned companies are profitable, such as large companies, they can choose to distribute some of those earnings to shareholders by paying out a dividend. Dividends are payments made by a corporation to its shareholder. It is the portion of corporate profits paid out to stockholders.
Stocks – Certificates of Ownership
Before the days of computers and the internet, a stock was represented by a stock certificate. This is a fancy piece of paper that showed proof of your ownership. Investors who bought stock received a stock certificate showing the name of the company, how many shares they own, and the name of the buyer.
Stock certificates were made of thick paper with fancy lettering and symbols on the paper. These papers proved stock ownership, so these were very valuable. In the past, when a person wanted to sell his or her shares, that person physically took the certificates down to the brokerage.
Today, physical stock certificates are increasingly rare, because most transactions regarding stocks are performed electronically, so you won’t actually get to see this document because your brokerage keeps these records electronically. Although, you can still get one if you ask for it.
Common and Preferred Stock
You can buy two kinds of stock, which are common and preferred stock.
All publicly traded companies issue common stock. Some companies also issue preferred stock. Preferred stock exposes you to somewhat less risk of losing money, but has less potential for total return on your investment compared to common stock.
If you hold common stock you’re in a position to share in the company’s success or its failures. The stock price of a company rises and falls all the time, sometimes by just a few cents and sometimes by several dollars, which reflects investor demand and the state of the markets.
There are no price ceilings, so it’s possible for shares to double or triple or more over time, although they could also lose value. The issuing company may pay dividends, but it isn’t required to do so. If it does, the amount of the dividend isn’t guaranteed, and it could be cut or eliminated altogether—though companies may be reluctant to do either if they believe it will send a bad message about the company’s financial health.
Holders of preferred stock, on the other hand, are usually guaranteed a dividend payment and their dividends are always paid out before dividends on common stock. So if you’re investing mostly for income—in this case, dividends—preferred stock may be attractive. But, unlike common stock dividends, which may increase if the company’s profit rises, preferred dividends are fixed. In addition, the price of preferred stock doesn’t move as much as common stock prices. This means that while preferred stock doesn’t lose much value even during a downturn in the stock market, it doesn’t increase much either, even if the price of the common stock soars. So if you’re looking for capital gains, owning preferred stock may limit your potential profit.
Another point of difference between common stock and preferred stock has to do with what happens if the company fails. In that event, there’s a priority list for a company’s obligations, and obligations to preferred stockholders must be met before those to common stockholders. On the other hand, preferred stockholders are lower on the list of investors to be reimbursed than bondholders are.