Those new to stock trading might be confused at first by the idea of “stocks” and “shares” and the million other terms related to the stock market. This is understandable; the inner workings of the stock market can be complex and confusing even for trading veterans.
Fortunately, stocks and shares are easy enough to understand, which is good since they form the foundation for the stock market (and publicly-owned companies in general) as we know it.
Here, I’ll explain the basics behind why companies have stock, what it means to own a share, what you can do once you own stock, and how that plays into the market.
What is Stock?
First, we’ll define “stock” as it pertains to stock trading and explain what, exactly, we’re talking about.
Stock in a company is another way of saying ownership in a company. In other words, a company’s stock represents the value of the company per share – or piece – of ownership. For example, if Company A has 100 shares of stock, the ownership of that company is divided into 100 separate pieces. If Warren Buffett owns 51 shares of stock, he owns 51% of the company (to simplify it a bit).
Stock can either be publicly held (i.e. anyone in the general public can buy and sell it in a stock exchange) or privately held (i.e. the only people with access to the stock are the owners, employees, and board members of the company itself). The difference between the two – why one company is public and traded on a stock exchange like NYSE or NASDAQ and why another company is private – depends on one word: financing.
Why Offer Stock?
Why issue stock at all? Why give ownership of your company to members of the public, who have no connection with the company at all yet can buy and sell shares of the company on a market? Financing is the reason. Simply put, issuing stock is one of the main ways a company can raise money for its operations.
For example, let’s say that Company A wants to build another factory, or expand its current factory so it can make more widgets and gizmos. The factory costs $1,000 to make (which is absurdly cheap as well as unrealistic, but we’ll use it for the sake of illustration). To raise the $1,000, Company A can hold what is called an initial public offering (IPO) and offer 100 shares at $10 per share.
The money raised is then used to build that new factory so it can make more widgets and gizmos and therefore grow the company. This is called equity financing because you are financing by selling equity, or ownership, in a company.
There are other ways to raise money, of course. Company A could have taken out a loan with a bank for the $1,000. There are problems with this, though. Taking on debt means you have to pay interest on the loan, which is fine if it’s just $1,000, but not so fine if it is a loan worth $10,000,000 or more.
Additionally, debt must be paid back; stock is never paid back because there’s nothing to pay back. (Technically, you can owe dividends on the stock, but you still control whether or not you even offer dividends.) Plus, investors get wary of a company when it has too much debt on its books, so sometimes you can’t take out a loan even if you want one – particularly for massive expansion projects.
So, instead of going through debt financing, a company will choose to go public through equity financing.
I Own Stock – So What?
Let’s say you own shares of a company. What you can do with that stock depends on the company itself.
There are two types of stock: common stock and preferred stock. Common stock carries with it voting rights. If you won common stock, you can vote on anything from new members to the Board of Directors to new initiatives and projects. Votes aren’t always binding (which is a maddening reality at times), but they are there nonetheless.
Preferred stock doesn’t carry with it voting rights, usually, but puts you at the head of the line when it comes to dividend payments, ahead of common stockholders. Preferred stock is like a bond: it represents equity and ensures that you receive dividend payments over a certain period of time. You don’t have as much risk with preferred stock – if the company goes bankrupt you receive payment before common stockholders, who may be out of luck – but you won’t be able to make nearly as much.
Of course, if you own stock, whether it is public or private, you can sell it, or liquidate it. For public stock, all you need is access to the stock market via a broker. For private stock, you have to dig a little deeper to find someone willing to buy the shares, or let the company repurchase the shares from you in stock buyback program.
- Stock, or equity, represents ownership in a company
- Companies can be public or private, depending on whether or not the public has access to buy and sell shares
- A share is a piece of stock, or ownership
- The two types of shares are common and preferred
- You can’t vote with preferred stock, but you gain first access to dividend payments and any division of assets in bankruptcy, just as if you were a creditor
- Owning stock means you can sell it as you desire, as long as you find a buyer