What Do Shares Of Stock Represent?
If you are thinking of starting to invest your savings in the stock market but don’t really understand much about what that means, we hope to help you today. Even if you already own shares of stock that have been invested by your employer or someone else, you may still benefit from this brief explanation of what it means to own shares of stock. This is not meant to be a deep study in everything you need to know about the stock market, but just a simple explanation of the basic idea of stocks.
Shares of Stock Represent Pieces of Ownership in a Business
Imagine you wanted to start a retail store with members of your family. You decide you need $100,000 to get the business off the ground so you incorporate a new company. You divide the company into 1,000 pieces, or “shares” of stock. (They are called shares because each piece of stock is entitled to a proportional share of the profit or loss). You price each new share of stock at $100. If you can sell all of the shares to your family members, you should have the $100,000 you need (1,000 shares x $100 contributed capital per share = $100,000 cash raised for the company).*
If the store earned $50,000 after taxes during its first year, each share of stock would be entitled to 1/1,000th of the profit. You’d take $50,000 and divide it by 1,000, resulting in $50.00 earnings per share (or EPS as it is often called on Wall Street). You could call a meeting of the company’s Board of Directors – the people the stockholders elected to watch over their interest since they couldn’t run the business – and decide to use the money to pay cash dividends, repurchase stock, or expand the company by reinvesting in the retail store.
At some point, you may decide you want to sell your shares of the family retailer. If the company is large enough, you could have an initial public offering, or IPO, allowing you to sell your stock on a stock exchange or the over-the-counter market. In fact, that is precisely what happens when you buy or sell shares of a company through a stock broker.
You are telling the market you are interested in acquiring or selling shares of a certain company and Wall Street matches you up with someone and takes fees and commissions for doing it. Alternatively, shares of stock could be issued to raise millions, or even billions, of dollars for expansion. To provide a real-world, historical illustration, when Sam Walton formed Wal-Mart Stores, Inc., the initial public offering that resulted from him selling newly created shares of stock in his company gave him enough cash to pay off most of his debt and fund Wal-Mart’s nationwide expansion. It ultimately led to his private family holding company, Walton Enterprises, LLC, through which the family holds the bulk of its Wal-Mart stock, becoming one of the largest fortunes in human history. – The Balance
What Does Owning Stock Mean For Me?
Now we know what shares of stock are. They are individual shares of a company that have a value based on the value of the overall company. They can be bought and sold. You buy them based on their value at the time you buy and you make a profit or lose money based on their value when you sell.
Let’s take a look at what it means for you to be an owner of stock.
Being an Owner
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.
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…
…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, at least in theory. In reality, individual investors like you and I don’t own enough shares to have a material influence on the company. It’s really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions…
…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. Owning stock means that, no matter what, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets. – Investopedia
Is owning stock a part of your overall financial plan?