Stocks (also called equities) are a type of investment where an investor buys shares (“stock”) sold by a corporation (or company). A share of stock represents partial ownership of the company and the investor becomes a shareholder. As a partial owner of the company, the investor has a claim to the earnings and assets of the company (such as receiving dividends paid by the company). For example, if an investor owns 15 shares of a company that has 100 total shares, the investor owns 15% of the company.
Why companies sell stock
Corporations (I’ll use the terms corporations and companies interchangeably) sell stock (or shares of ownership) to raise capital (money). Companies use this capital for a variety of projects such as investing in research and development or buying new equipment.
The benefits of stock ownership
Owning stock provides the opportunity for investors to increase wealth through two primary ways:
- Increased value – If the value of the stock increases (meaning if other investors are willing to pay more for the stock) then the investor can sell the stock at a profit.
- Dividends – Some companies return a portion of their earnings to investors in what is called a dividend. Dividends are essentially a small payment generally paid on a quarterly or annual basis.
Types of stock
There are two types of stock, common stock and preferred stock. Each come with different rights of ownership. Owners of common stock generally have with voting rights, while preferred stock generally does not. Voting rights enable shareholders to vote on things such as board members of the corporation. Preferred stockholders receive dividends before common stockholders and have priority claim to assets in the event of bankruptcy.
How stocks are traded
Although stock is originally sold by corporations to investors (via Initial Public Offerings (IPO)), most investors actually purchase shares from other investors on stock exchanges (or stock markets). The NYSE (New York Stock Exchange) and the Nasdaq are two examples of stock exchanges in the United States. To purchase stock, investors must use a brokerage (stock broker) to make stock transactions on the exchanges.
The value of a stock depends entirely upon the price investors are willing to pay for a share of stock. The stock quotes commonly shown on many websites are simply the last price an investor paid for a share of the company’s stock. Because the value of the stock depends upon what investors are willing to pay for a stock, the value can fluctuate, sometimes drastically, over time.
Because stock prices fluctuate based on what investors are willing to pay for a share of ownership, the primary risk of owning stock is a decrease in the value of a stock. The price investors are willing to pay for a stock depends on many different factors. Some examples include the profitability of the company, news related to the company, and even external factors such as global economic conditions.