What in the world is a stock?
“I just lost all my Apple stock!” or “I just bought ten shares of Nike!” are just some of the phrases you might hear if you have friends who invest in stocks. You may want to get involved in stocks as well, but aren’t sure what they are and how they work. If that’s the case, this article is for you.
Stocks are the most popular asset to invest in. They are relatively lower risk investments due to them having a reliable reputation in having strong average returns.
But what is a stock and how do you make money from it?
A stock — also called an equity — is a purchasable item that represents ownership of a fraction of a company (a group of stocks are called shares). It’s a give and take relationship. By buying a stock, you are giving a company money to help fund their operations. But, also, by buying stock, the company is granting you possession of a portion of its assets and earnings relative to how many shares you purchase. For example, if you own a single share of a company that has 10 shares available for purchase, you would own 10 percent of that company’s assets and earnings. It is important to note, though, that this shareholder does not own corporations, but instead, the shares of the corporation. This means that the shareholder cannot just do whatever they want with the company’s assets because the company still has full ownership of their own assets. This principle is known as separation of ownership and control.
Think of it like this. Imagine a pizza box containing an untouched pizza cut into six distinct slices. Let’s say you’re hungry and want to buy one of the six slices for a certain price. When you buy the slice, you are giving your money to the pizza vendor, which they might use for a variety of things: buying ingredients to make more pizzas, hire more employees, add more items to their menu. In return, you now own a portion of that pizza and benefit by satiating your appetite. And remember, it would be incorrect to say you own seventeen percent (1/6) of the company because you actually own seventeen percent of the company’s total shares.
In the same way, by buying stock, you are giving the company your money with the expectation you will receive ownership over a portion of the company’s assets and profits.
But how exactly does owning stock benefit you, the buyer? Owning stock gives you several privileges, the main ones being the fact that you can vote in shareholder meetings and receive portions of the company’s profits through dividends.
Most common investors do not care much for the ability to vote in the shareholder meetings, but you may find it a point of interest that the more shares you own, the more significant your voting power, which allows you to indirectly influence the direction of a company.
Similarly, you also earn a larger portion of the company’s profits by owning more shares. As mentioned before, these profits are distributed through dividends, which are determined by the board of directors and can either be paid as cash or additional stock.
However, it’s important to note that not all stocks have the exact same benefits. In fact, there are two main types of stock that are differentiated by what the stockholder gains: common and and preferred stock. Generally, common stockholders receive dividends and the right to vote in shareholder meetings. Preferred stockholders, on the other hand, receive a larger claim on a company’s profits and assets but generally lack voting rights.
Now, the next time a friend mentions something about losing money from his stocks or investing in an up-and-coming startup, hopefully you’ll have a better idea of what they mean and maybe even join in with them!
