Definition:
A stock represents partial ownership of a company. When you purchase a stock, you’re buying a piece, or a “share”, of a company. By owning a share, you own a small fraction of the company’s assets and have a claim on its future earnings.
Understanding a Stock
Stocks play a crucial role in the global economy as they enable companies to raise funds by selling shares (pieces of ownership) to the public. These shares can be bought or sold on stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq, or in some cases, sold privately. The Securities Exchange Commission (SEC) has regulations in place to oversee how companies handle their stocks. There are two main types of stocks: common stock, which grants voting rights to shareholders, and preferred stock, which offers fixed dividend payments without voting rights.
Example:
Let’s say a company has 100 shares of stock out there, and you happen to own 1 share. That means you own 1% of the company! The value of your shares will be roughly 1% of the company’s market capitalization, or the total value of all shares outstanding.
Simple Explanation
Owning a stock is similar to having a share of ownership in a cupcake business…
So, let’s assume that you’ve got a dream of opening your very own cupcake shop, but all you’ve got is a measly $1,000 to start with. Not nearly enough, right? Well, one way to make it happen is by reaching out to your friends and family for some financial support. Let’s say four of your buddies chip in $1,000 each, giving you a total of $5,000 to kickstart your business. In return for their investment, you might agree to give them 20% of the business and its profits. Of course, they’ll also share in any losses the business might face. It’s kind of like how stocks work, just on a smaller scale.
Learn more…
What is the history of stocks?
Back in the day, the Romans had a clever way of getting their citizens involved in public works. They came up with this thing called a stock-like instrument, which contractors would sell to raise capital for projects. It was like a piece of their businesses, and they called it ‘lease holding.’
Now, let’s jump ahead to the 1600s and talk about the East India Company (EIC). They were the pioneers of joint-stock companies, making a name for themselves by trading commodities in the Indian Ocean region. And guess what? Today’s limited liability company (LLC) is basically a modern version of the joint-stock company. Pretty cool, right?
What are stocks vs. other instruments?
Other instruments can be bonds, futures and options. There are clear differences between bonds and stocks. Bonds are debt-based instruments where investors lend money and receive interest to the company or government issuing the bond, without ownership in the company. However, Bondholders may have more security than stockholders. Stocks are traded on exchanges, while bonds are typically traded over the counter.
Futures and Options are not like stocks because they are derivatives, meaning their value depends on another asset like commodities, shares, or currencies. Instead of owning the asset, they are contracts that follow the changes in the underlying assets.
How does the stock market work?
When we talk about the “stock market“, we are referring to a range of markets where individuals engage in the buying, selling, and issuing of stocks in publicly traded companies.
The stock market comprised of various individual stock exchanges. The most well-known ones in the United States are: the New York Stock Exchange (NYSE), Nasdaq, the Better Alternative Trading System (BATS), and the Chicago Board Options Exchange (CBOE). These exchanges, along with several others, collectively make up the U.S. stock market.
While it may be called the ‘stock market’ or the ‘equity market’, it’s important to remember that it’s not solely focused on stocks. You’ll also find other financial instruments such as bonds, commodities, currencies, and derivatives being traded there.
What are the different types of stocks?
Common Stock
If you’re a shareholder in a company, it typically falls into the category of common stock. Common stock offers a significant benefit of voting rights, where each share generally corresponds to one vote. Shareholders holding common stock can actively engage in annual general meetings and play a role in important decisions such as electing board members, stock splits, or determining the company’s overall strategy.
Preferred Stock
If you’re an investor who prefers a reliable dividend income and doesn’t want to vote on corporate matters, you might consider investing in preferred stock. It’s similar to bonds in that the company can repurchase it at a predetermined price.