A stock is defined as a share of ownership of a company. If you own XYZ stock, depending on how many shares you purchased, you own a percentage of that company. You also own a percentage of the company’s’ profits. A single share of the company represents fractional ownership of the company and it is relative to the total number of shares the company has issued. A stock is also commonly referred to as equity, if someone says I own equity in XYZ company, it is the same as owning shares and owning stock of XYZ company.
There are two main types of stock: Common stock and Preferred Stock. The differences between the two are mostly the rights you are entitled to.
Key Features of Common Stock Ownership:
- Ownership: As a common stock owner, you own a piece of that company. The amount will depend on how many shares you own and what percentage of the company each share represents – that will vary from company to company.
- Dividends: As an owner, you are entitled to share in the profits of the company. This could be in the form of dividends, or perhaps, if the company doesn’t elect to pay dividends, the stock will rise in value and you, the investor, will be rewarded with a more valuable ownership piece.
- Voting Rights: As a common stock shareholder, you are generally able to vote on major corporate actions and who represent the shareholders on the board of directors.
- Right to Assets: If the company ever goes out of business or decides to sell everything. Common stock shareholders split up whatever is received for the assets of the company. Although in this case, common stockholders are third in line to be paid. 1st is bondholders, 2nd is preferred shareholders, 3rd and last is common stock holders.
- Ownership Term: As a common stock owner, you own that piece of the company for as long as you elect to keep those shares. Common stock is in perpetuity (aka forever)
Key Features of Preferred Stock Ownership:
- Ownership: Just like common stock holders, preferred stock holders generally have an ownership stake in the company.
- Dividends: : As a preferred shareholder, you are entitled to a dividend payment. That dividend payment is usually a fixed amount (e.g. 5% of the initial price) and these payments are “preferred” to common stock holder dividend payments. Meaning if a dividend payment is missed to preferred shareholders, those missed payments must be made in full before common shareholders can get a dividend payment.
- Voting Rights: Although preferred stock holders get preference with dividends, they don’t get voting rights. This is the price preferred stock holders pay to move up the pecking order.
- Right to Assets: If the company ever goes out of business or decides to sell everything. Preferred stock holders are 2nd in line to collect, only behind bondholders but ahead of common stock holders.
- Unique Features of Preferred Stock: Often times preferred stock comes with what is called call or put options – call options is the most popular with preferred stock. Basically, it means that the company has the right to but the stock back from the investor. For what? Well that depends on the stock. Maybe the investor gets a premium on the initial price, or perhaps they get common shares. It depends on the situation and the possibilities are almost endless.
- Ownership Term: The time horizon of preferred can vary. Although many are in perpetuity, some have limits with defined end dates.
The goal of investing in stocks is to see your initial investment grow, as the company grows. If the business is successful over time, then its stock will usually increase over time also. Although this isn’t always true when looking at the stock of a company in a shorter term.
The reason you can see the price of a stock increase and decrease many times in a shorter period is because the stock is traded on the public markets and its price is subject supply and demand of the market. This can result in the price of the stock at a time not matching up with the fundamental health of the company, whether good or bad.
A business is started by a person or a small group of individuals who invest their own money into starting the business. The amount of money each individual may invest gives them a percentage of ownership of that business at the time. At this time the business is considered private, but once a business reaches a certain size, the owners of the business may consider taking the company public. This means the company will sell a chunk of the business to the public who is allowed to buy shares of the company and give themselves a ownership percentage of that company. Buying a share of the company makes you a part business owner.
Companies sell stock in their company for a number of reasons, but the first initial public offering is when the company goes from being a privately held to being a publicly owned company. This will result in a large offering of stock to the public, and where you can buy shares and own a percentage of the company. This tends to happen as a company grows and they need to find a way to raise more money to run the company. For example, say you, Bob, Jimmy and Steve start a company and you all invest your own money, say $25,000 each, that gives you each an equal percentage of the company, totaling $100,000. Well as your company grows larger and you need to hire more people to run the business and need more cash to purchase services and or goods to run the business itself, you may consider going “public.” When this time comes, you often turn to Wall Street and look for help and guidance on how to transition the company from being privately held, by you, Bob, Jimmy and Steve, to offering shares of ownership to people outside the company. Now you must act in the interest of others owning the company also and strive to be as profitable as possible for your shareholders. Being a public company and allowing the public to invest in your company, comes with a lot of pressure and scrutiny. You must act in the best interest of every one of your shareholders and not just yourself, or Bob, Jimmy or Steve anymore.