Plain and simple, stock is a share in the ownership of a
company. Stock represents a claim on the company's assets and earnings. As you
acquire more stock, your ownership stake in the company becomes greater.
Whether you say shares, equity, or stock, it all means the same thing.
Who are Stockholders?
Holding a company's stock means that you are one of the many
owners (shareholders) of a company, and, as such, you have a claim (albeit
usually very small) to everything the company owns.
Yes, this means that technically you own a tiny sliver of
every piece of furniture, every trademark, and every contract of the company.
As an owner, you are entitled to your share of the company's earnings as well
as any voting rights attached to the stock.
Being a shareholder of a public company does not mean you
have a say in the day-to-day running of the business. Instead, one vote per
share to elect the board of directors at annual meetings is the extent to which
you have a say in the company.
For instance, being a Microsoft shareholder
doesn't mean you can call up Bill Gates and tell him how you think the company
should be run.
In the same line of thinking, being a shareholder of Anheuser
Busch doesn't mean you can walk into the factory and grab a free case of Bud
Light!
The management of the company is supposed to increase the
value of the firm for shareholders. If this doesn't happen, the shareholders
can vote to have the management removed.
The importance of being a shareholder is that you are
entitled to a portion of the company's profits and have a claim on assets.
Profits are sometimes paid out in the form of dividends.
The more shares you
own, the larger the portion of the profits you get. Your claim on assets is
only relevant if a company goes bankrupt. In case of liquidation, you'll
receive what's left after all the creditors have been paid.
What is Stock Certificate?
A stock is represented by a stock certificate. This is a
fancy piece of paper that is proof of your ownership. In today's computer age,
you won't actually get to see this document because your brokerage keeps these
records electronically, which is also known as holding shares in street
name.
This is done to make the shares easier to trade. In the past when a
person wanted to sell his or her shares, that person physically took the
certificates down to the brokerage. Now, trading with a click of the mouse or a
phone call makes life easier for everybody.
Another extremely important feature of stock is its limited
liability, which means that, as an owner of a stock, you are not personally
liable if the company is not able to pay its debts.
Other companies such as
partnerships are set up so that if the partnership goes bankrupt the creditors
can come after the partners (shareholders) personally and sell off their house,
car, furniture, etc.
Why Does Company Issue Stock?
Why does a company issue stock? Why would the founders share
the profits with thousands of people when they could keep profits to
themselves?
The reason is that at some point every company needs to raise
money. To do this, companies can either borrow it from somebody or raise it by
selling part of the company, which is known as issuing stock.
A company can borrow by taking a loan from a bank or by
issuing bonds. Both methods fit under the umbrella of debt
financing. On the other hand, issuing stock is called equity
financing.
Issuing stock is advantageous for the company because it does
not require the company to pay back the money or make interest payments along
the way.
All that the shareholders get in return for their money is the hope
that the shares will some day be worth more. The first sale of a stock, which
is issued by the private company itself, is called the initial public offering
(IPO).
It is important that you understand the distinction between
a company financing through debt and financing through equity. When you buy a
debt investment such as a bond, you are guaranteed the return of your money
(the principal) along with promised interest payments.
This isn't the case with
an equity investment. By becoming an owner, you assume the risk of the company
not being successful.
Just as a small business owner isn't guaranteed a return,
neither is a shareholder. As an owner, your claim on assets is lesser than that
of creditors.
This means that if a company goes bankrupt and liquidates, you,
as a shareholder, don't get any money until the banks and bondholders have been
paid out; we call this absolute priority.
Shareholders earn a lot if a company
is successful, but they also stand to lose their entire investment if the
company isn't successful.
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