Stock is basically a piece of the company. When you own stock, you partially own the company. The more shares of stock you own, the more of the company’s assets and earnings belong to you. People use “stock,” “shares,” and “equity” interchangeably.
What is involved in owning stock?
If you are one of the many people who own stock in the company, you are considered to be a shareholder because you own a share of the company. This means that you have a (usually tiny) claim to everything owned by the company, including things like furniture and trademarks. You have a legal claim to your share of revenues. Another bonus is that you have the right to vote in any company elections, giving you a voice in the direction your company goes.
A stock certificate is a physical paper that proves your ownership of the stock. Since the world has become so fast paced and technical, you more than likely won’t ever see your certificate – it’s often kept in a digital record by your broker. Having your broker keep the digital certificate makes stock easier and faster to trade. Previously, if you wanted to sell your shares, you would have to take your paper certificates to your broker. Now, you can just log onto a website and click a mouse.
While owning stock means that you have voting rights, it doesn’t entitle you to make everyday decisions for the business. The amount of shares you own equals the amount of votes you have in board member elections at the annual meeting of the company. So, if you own 100 shares of a company, you get 100 votes at the meeting. Considering there are typically thousands of shareholders for the bigger companies, most holding multiple shares, the company does not have time to consult shareholders every time they want to buy a drink machine or hire a new employee. Likewise, you aren’t entitled to any free products (bummer). However, voting for the board is not the only vote you can cast. If the managers in the company are not improving the company’s value, then shareholders can vote to remove or replace them. However, casual investors still don’t typically have enough shares for their votes to make an impact on their own. Typically, it’s other large companies and millionaires that own the largest stakes of the company and have the most voting power.
For us “Average Joes,” who don’t own enough stock to outplay the big investors, not having enough power in the company isn’t that bad. Think of it this way: you want to make money without having to work a lot, right? The most important part of being a shareholder is that the
company owes you part of their profits and assets. Sometimes, if you cash in your stocks, the profits owed to you are paid out in something called dividends. Only in the case of the company’s bankruptcy are you entitled to a claim on the assets of that company. If the company is liquidated, you only get what’s left when all of the creditors have been paid. So, please remember that your stock shares are only worth as much as your legitimate claim to the company’s profits and assets.
Limited liability is another important component of stock. This means that you are not to be held liable if debts are not paid by the company. There are other kinds of companies that do allow creditors to pursue the stockholders if the company loses everything, but owning stock in a company means that you can only lose as much as you’ve invested. You will not lose your personal property and other assets.
Debt or Equity? If you’re wondering why companies issue shares of stock to complete strangers that will have a claim to profits, it’s because the company you’re investing in is trying to raise money. In lieu of borrowing money, they can choose to sell stock to investors. This is called “issuing stock.” If the company takes out a loan, it is utilizing “debt financing.” If they sell shares instead, it’s known as “equity financing.” Equity financing typically provides more of an advantage, because the company does not have to worry about repaying money or paying interest. Instead, the stockholders receive a chance that they may be able to share in the profits while taking the risk that they may lose their investment. If you invest wisely, and have a bit of luck, you can make a killing. A company’s first stock sale is called an IPO (Initial Public Offering) and is sold by the actual company instead of a broker.
Understanding the difference between debt and equity financing is important. If you buy a bond, which is a type of debt investment, your investment is guaranteed, as well as interest payments. Equity investments are riskier for the stockholder. If you own stock in the company, you always have the risk that the company may be unsuccessful, claiming bankruptcy and/or liquidating. In this case, the creditors get paid out first, and shareholders get whatever is left.
It’s possible to earn a LOT if the company you invest in is successful, but there’s always the risk of losing out. Knowing Your Risk Stocks hold no guarantees, this cannot be emphasized enough. Sometimes, dividends are paid, but many companies don’t do this. Even if the company has traditionally paid dividends to its stockholders, there’s never an obligation for them to do it in the future. If the company does not pay out dividends, the stockholder can only make money if the stock appreciates in value.
So far, the idea of risk has sounded very negative. However, on the good side, if you take on greater risk, you could receive a greater return. This scenario is why stocks have traditionally been more popular than bonds and savings accounts. Stocks have historically averaged around 10 to 12 percent return over the long run, while savings accounts and bonds don’t come close.