Intro to Stocks

By   September 18, 2012

What is a stock?

“Stocks” are the most basic part of investing; stocks are one of the most common tools used to invest in companies.stock

Definition

Stock is defined as a piece of a company; if you own a company’s stock, you actually own a part of the company itself (including its assets, like chairs, vehicles, and buildings). That does not mean that if you own $100 in shares you can go to the company headquarters and exchange it for a chair, but it does mean that if the company were to go bankrupt and all of its assets were liquidated, you may be eligable to receive some small percentage of whatever is left after all the creditors are paid.

What Does Owning Stock Get Me?

Since you own part of the company, you are now involved in some of its management decisions, and you are entitled to some of the company’s profits. What exactly you are entitled to depends on the amount of stock that you own. You also have the right to sell your stock at a later date at whatever price you want (although it is generally determined by the current market price).

Types Of Stock

There is more than one kind of stock as well; almost all stock sold on a stock exchange (and that you can readily buy) are “Common Stock”, but there also exists “Preferred Stock”.

Common Stock

Common stock is the kind you would buy through a stock broker or on your own. Common stock generally gives one vote for every share owned at shareholder meetings, but there are also some classes of “non-voting stock”. For large companies where a single, or even a thousand, shares does not give much of a voice when voting, the difference between the two is negligable.

Common stock holders may also be entitled to dividend payments, if the company makes them. Corporate profits (revenue minus expenses and investments) are usually issued back to shareholders as a dividend; some companies offer higher dividends specifically to attract more shareholders. If you receive a dividend, and how much, varies widely by company. There can also be multiple classes of common stock.

Preferred Stock

Preferred stock generally does not have voting rights, and you generally will not find them trading on an exchange. However, preferred stock shares have the benefit of “preference” for dividend payments; if a company decides it is going to pay dividends, preferred stock holders may get a bigger share, and be paid before, common stock holders. Preferred stock holders are also entitled to be paid first if a company goes bankrupt and all the assets are sold off.

The Difference Between Stock and Bonds

When you buy a stock, you are buying a piece of a company. A bond, however, is only a piece of debt; a bond is a promise that a company makes to pay you back an amount you lend them, plus interest. Hence, if you own a bond, you are only lending a company money, but if you own a stock, you own part of the company itself.

Bonds also pay interest based on the company and how much you bought the bond for, while stocks’ value is determined only by the “market value”; how much other investors are willing to pay to own part of that company.

Where Does Stock Come From?

New stock in a company can come from two places: New Issues and Stock Dividends (or Splits)

New Issues (IPO)

A new issue of stock is when a private company decides to “Go Public”, and issues shares of stock for anyone to buy. This is often called an IPO, and when large private companies go public, it can be a very exciting event with huge fluxuations in the stock’s price in the first weeks while the market decides on a fair price for the shares.

Private companies “Go Public” and issue stock primarily to raise money: as they sell the shares in the company, the original owners allow the public to vote on some management decisions in exchange for the cash raised in the stock sale to re-invest and help the company grow.

Stock Dividends (Splits)

Companies may also to issue new shares of stock after the IPO. This can be done by giving all current shareholders additional shares in proportion to how many shares they currently have; for example they can say that for every 10 shares you own now, they are issuing you one extra share.

This would be a 10% stock dividend, and the market price for the stocks would drop by 10% (although all shareholders still have the same ‘value’).

If the stock dividend is large enough (usually about 20%), it is instead called a “Stock Split”. There are many reasons why companies would want to have a stock dividend or split, but they usually happen for one of two reasons:

Attract Attention and Increase Trading

Companies may split their stock to attract attention to the company through the hype that can come from a stock dividend. However, the simple act of there being more shares in circulation may encourage people to buy and sell more, since each individual share takes up a smaller percentage of a portfolio

Lower The Price

Some large companies like to have their stock price stay in a certain range. One reason for this is that the more expensive a stock, the fewer people who can afford to buy it (or buy an additional share), so splitting stocks can help it become more affordable, and increase the total value of all stocks in the long run.

History Of Stocks

Stocks trace their origins back to the Roman Empire, where large, private companies that carried out some public duties would sell shares of stock to Roman citizens for the same reasons companies do today; raise cash and grow their business.

Over the centuries, Joint Stock Corporations were often chartered by monarchs for large projects that the government simply did not want to invest all the cash (and therefore risk) to fund; for example many canal projects, railroads, and roads in Western Europe were built by Joint Stock Corporations; private investors willing to to take the risk that a project would fail in exchange for some of the profits if it succeeded.

During the Age of Exploration, joint stock corporations were what funded explorers to voyage across oceans, and later ship goods across continents. The British East India Company is perhaps the most famous of these, which was involved in everything from the exploration of Canada and the Americas to the British conquest of India, and even the slave trade.

Wall Street in the United States was formed by groups of investors that would meet near a buttonwood tree on Wall Street in New York City to buy and sell shares of stock they owned in these Joint Stock Corporations, and the financial center of North America grew from there!

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