What are stocks
Stocks - the definition and details
Issuing and selling shares of stock is a common method corporations use to raise capital in order to carry out the goals of the company, such as expansions and improvements, without borrowing large amounts of money. Without the income generated by the sale of shares of stock, many companies would not be able to come up with the cash to accomplish these goals
Stocks/shares - Definition: Stock is a share in the ownership of a company. In other words, this share/stock represents a claim on a company’s assets and income. The more the percentage of stocks acquired of a company, the bigger is the ownership stake.
Synonyms: Shares, equity.
By owning stocks of a company, the investor becomes one of the many owners/shareholders of the company and thus, has a claim (usually small) to a company’s assets. In other words, the investor owns a tiny portion of every piece of equipment, furniture, trademarks and any contracts of the company. Owning stocks also entitles the investor to his share of voting rights, apart from a share of company’s earnings.
A stock certificate represents a stock. This certificate is proof of stock ownership. Unlike a few decades ago, in today’s computer age, these records are kept electronically so you may not get to see a physical certificate. This electrical keeping of records is also known as holding shares "in the street name". Unlike in old days when stock certificates had to be taken physically to the broker, advancement in technology has enable us to trade stocks with a click or a phone call.
Being a shareholder in a public company doesn’t give the investor the authority to have direct control on day-to-day running of the company. The authority of shareholders is limited to voting rights to elect a board of directors at the annual meeting. For instance, being an ArcelorMittal shareholder doesn’t mean you can call Mr. Laxmi Narayan Mittal and advise him on how the company should run. Similarly, a shareholder of Anheuser Busch cannot walk into the factory and grab a bottle of Bud Light.
The aim of company management is to increase the value of the firm for the shareholders. In theory, if the management fails to achieve this primary goal, the shareholders can vote to remove them. In reality, individual investors don’t own enough shares to exercise any influence on the company. The big boys (major shareholders) like large institutional investors and billionaire entrepreneurs are the ones who make decisions.
This is a blessing in disguise for the ordinary shareholder since not being able to manage the company isn’t a big deal. This fits well with the ideology of making the money work for you. Profits are paid in form of dividends. Which means, the more shares one owns the bigger the dividends. The claim on assents is relevant only when a company goes bankrupt or liquidates its assets. The creditors have first stake on money recovered from liquidation, the shareholder(s) gets the rest. A stock is important because of the claim on assets and earnings otherwise it is a worthless piece of paper.
Another benefit of holding stocks is its limited liability. This means the stock holder is not personally liable if the company is not able to pay its debts. The liability of the stock holder is limited to the value of the stocks he owns.
Debt vs. Equity
The reason owners issue stocks is to raise money. If a company borrows money from bank or issues bonds - both ways are considered ‘debt financing’. On the other hand, issuing stocks is called ’equity financing’. The first sale of a stock issued by the private company is called the initial public offering (IPO).
It is important to understand the difference between debt financing and equity financing. Buying a debt investing such as bond guarantees the return of principal plus the interest payments. Buying equity shares can be more profitable but is very risky too because in case of bankruptcy the shareholder gets the money only after the creditors are paid out, this concept is called absolute priority. If the company succeeds the shareholders earn a lot however, if the company fails, the shareholder may lose his entire investment.
The risks are huge. The company may or may not give dividends and in that case, the only way the investor makes money is if the price appreciates in the market. With big risk comes the big possible profits. This is why historically stocks have outperformed bonds and savings accounts. Stock market investment has had an average return of 10 - 12% on an average.
Table of contents: Stock Market tutorial
1. Stocks: An introduction.
2. What are stocks ?
3. Types of stocks.
4. How stocks trade
5. How stock prices change ?
6. How to purchase stocks ?
7. How to read a stock table/quote.
8. Animals in stock market
9. Stock Market Tutorial: Summary.