This is the first article in our guide to stocks. In this article, we’ll give you an introduction to stocks – what they are, where they came from, and what it means to own them.
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What the heck is a share of stock?
Want to know what stock is? Simple – it’s a share of ownership in a company. When you buy a stock, you’re buying a very, very, very small piece of ownership in a company that has decided to sell itself, in part of in whole, to the general public. That’s it. Seriously. If a company has sold one billion shares to the public, and you own 1 share of stock in that company, then you own a billionth of that company.
Cool, I’m an owner! What do I get?
Just because you own a few shares of Coke, it doesn’t mean you can just waltz into a grocery store and grab some soda. But don’t fret. As a stock owner, you’re entitled to something much more important – a claim to some of Coke’s profits. But again, there’s a problem. You can’t just call up the manager of Coke’s bank account and demand a wire transfer tomorrow. Only Coke’s board members can authorize a payment to the company’s shareholders, you.
As a shareholder, you get to vote on who gets on Coke’s board of directors, but let’s be honest, as an individual investor, you don’t care about who’s on Coke’s board. The only thing you’re looking for is your share of Coke’s earnings (paid out as a dividend) and a higher stock price so you can sell your stock at a profit.
As an owner of the company, though, there’s one thing to keep in mind. If the company goes bankrupt, chances are, you won’t actually get any money that the company has. By law, the company first has to repay any debts that it owes. After it does that, then you can get paid, but if the company went bankrupt, what’s the likelihood that it will have anything left over for you?
Why do companies sell stock?
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Imagine you had started a great company producing flying alarm clocks (let’s just go with it). You’ve been able to set up a factory to produce and sell thousands of alarm clocks in California, but now you’re getting orders in from the rest of the country and you can’t keep up with them. You need to open more factories, you need to pay more workers, you need to set up supply chains and coordinate with distribution centers. What do you do?
You could take out a loan from the bank, or, you could sell some (or all) of your ownership in the company to raise money for growth and expansion. If you decide to go that route, you’ll generally contact one of the big Wall Street banks to take care of the dirty work for you – figuring out how many shares to sell and at what price, finding buyers for your stock, complying with SEC guidelines for reporting, etc. Of course, the big Wall Street bank will charge you a fee for all of their work.
The bank will then buy all of the shares that you’ve decided to offer themselves. Then, at some point in the future, they’ll resell those shares to the general public in an initial public offering, or IPO. Once they’re out in the public, your company is no longer involved in the process. Now, your job is to keep growing the company so that its new owners make a nice, hefty profit. If you do a good job, more people will want to buy shares in your company, driving up the stock price, and keeping your shareholders happy. If you don’t, more people will sell your stock, causing your stock price to tank, which may eventually lead to your new bosses outing you and in favor of finding a new CEO.
But ultimately, this IPO will be a pretty good deal for you, too. As the founder of this hugely successful flying alarm clock company, you’ve probably kept a large chunk of shares for yourself. Now that these shares are trading freely on the market, you’ll be able to sell them for a pretty penny and cash out, if you want. Just keep in mind that as part of the IPO, you’ll be prevented from selling your shares for a specific period of time – usually six months.
Back to reality
Hopefully, you now have a better idea of what all the fuss is about. Stocks and the stock market are a major part of everyone’s daily lives, at least in some small way. Now that you know a bit more about what a stock is, you’re ready to get into the details. In the next post, we’ll talk about how stocks are traded and who’s buying and selling them. Read on!
