What Are Stocks?
A stock, also known as equity, is a financial security representing ownership in a fraction of the issuing corporation. Units of stock are referred to as shares. Ownership of these shares entitles the stockholder to a proportion of the corporation’s assets and profits corresponding to the amount of stock owned.
Stocks predominantly trade on stock exchanges and are cornerstone assets in many investors’ portfolios. To shield investors from fraudulent activities, stock trades must comply with governmental regulations.
Key Takeaways
- A stock signifies proportional ownership in the issuing corporation and trades mainly on stock exchanges.
- Corporations issue stock to gather capital needed for business operations.
- The two main types of stock are common and preferred.
- Historically, stocks have offered superior long-term investment returns.
Delving Into Stocks
Corporations raise funds for their business activities by issuing stock. The holders of this stock, known as shareholders, may have claims on the company’s assets and earnings. For instance, owning 100 shares of a company with 1,000 outstanding shares gives the shareholder 10% stake in the company’s assets and earnings.
While stockholders don’t own the corporation per se, the corporation, treated as a legal person, owns its assets, borrows, and can be sued. This legal separation between corporate property and shareholders’ assets distinctively limits liability. Even in bankruptcy, shareholders aren’t at risk of losing personal assets, but their stock value may plummet.
Shareholder Defined
A shareholder is an individual, company, or institution owning at least one share of a company’s stock, reflecting ownership in the company.
The Essence of Ownership
Stockholders own shares issued by a corporation, which owns its own assets. Owning a portion of the company’s shares does not equate to owning a portion of the company itself but rather the shares. This separation of ownership and control means shareholders are entitled to rights like voting, receiving dividends, proportional share in profits, and the ability to sell their shares.
Share ownership translates to a tangible influence through voting power, more pronounced with majority ownership, which can control corporate decisions such as board appointments.
Comparing Common and Preferred Stocks
Two principal types of stock exist: common and preferred. Common stock typically grants voting rights at shareholder meetings and potential dividends. In contrast, preferred stockholders usually lack voting privileges but have a stronger claim on the company’s assets and earnings, receiving dividends before common stockholders, and having priority during liquidation. Companies like the Dutch East India Company pioneered common stock issuance in 1602.
Differentiating Stocks and Bonds
Stocks are issued by corporations needing to raise capital for business growth or new ventures. They differ significantly from bonds, where bondholders are creditors accruing interest and principal repayments ahead of shareholders in credit priority. Stocks, considered riskier due to low priority in bankruptcy, can yield nothing in those scenarios, unlike bonds securing creditor investments.
Purchasing Stocks
Stocks are frequently traded on exchanges like the Nasdaq or NYSE. Following a company’s IPO, its stocks become available for exchange trading, usually managed through brokerage accounts listing purchase prices (bids) and selling prices (offers). Stock prices are influenced by market supply and demand, among other factors.
Earning Income from Stocks
Stock ownership can generate income in two primary ways: dividends and capital appreciation. Dividends are profit distributions to shareholders, while capital appreciation refers to the rise in a stock’s market price. For instance, buying at $10 and selling at $11 results in a $1 gain per share.
Is Investing in Stock Risky?
All investments carry risk, including stocks, which can lose value amidst market downturns or due to corporate decisions. While stock investments can be volatile, they have traditionally outperformed other investment forms over the long term.
The Bottom Line
Owning stock symbolizes fractional equity ownership in a corporation, varying from bonds that serve as loans to collect periodic payments. Stock issuance helps corporations gather capital for expansion or new projects. The type of stock held—common or preferred—defines ownership rights and benefits.
Related Terms: bonds, capital appreciation, stock exchange, stockholder, initial public offering (IPO), dividends, shareholder.
References
- New York University Stern School of Business. “Historical Returns on Stocks, Bonds and Bills: 1928-2021”.
- U.S. Securities and Exchange Commission. “Stocks”.
- American Bar Association. “Does ‘We the People’ Include Corporations?”
- University of Pennsylvania Carey Law School. “Independent Directors and Controlling Shareholders”.
- European Central Bank. “Keynote Speech by Marc Bayle de Jessé, Director General Market Infrastructure and Payments, ECB, at the Central Bank Payments Conference, Amsterdam, 27 June 2017”.
- Small Business Chron. “How Does a Shareholder Make Money?”
- FINRA. “The Reality of Investment Risk”.
