What is Stock: Guide to What Stocks Are & How They Are Created

Investing Advice 1

What is Stock?

What is stock? The word is used freely to describe ownership in the stock market based on a specific company. But when you buy a company’s stock, exactly what are you buying?

Investor.gov’s stocks and shares definition is as follows:

“Stocks are a type of security that gives stockholders a share of ownership in a company. Stocks also are called ‘equities’.”

So what exactly does that all mean for those who are looking for ways to invest in the stock market?

A share of stock gives you an ownership position, also called “equity,” in the company that issued the stock. For example, if you buy 100 shares of IBM, you own a very small part of the company. This does not mean you own any specific asset held by the company; it does mean you own a piece, or proportional share, of the overall corporation.

As an owner of this stock, you’re generally entitled to sell or trade your share when you choose. Ideally, you’d liquidate your investments at a time where you’d get more money for your stock than what you initially purchased it for. Depending on the type of stock you purchase, you may be entitled to certain rights within the company, outside of your financial investment.

Quick note: If you’re already well-versed on what a stock is and how it works, check out our Guide to Investing in Stocks.

Types of Stock

There are two main types of stock: common stock and preferred stock.

  • Common stock investors have a monetary and directive stake in a company. This means they’re entitled to participate in voting at shareholder meetings, and they also receive company dividends.
  • Preferred stock doesn’t typically grant shareholder voting rights, but investors do receive dividend payments before common stockholders do. This also means that if the company faces bankruptcy, preferred investors are generally considered priority when the company returns shares.   

How Does Stock Trading Work?

So, now that you can answer the question, “what is a stock?” It’s time to learn how companies issue stocks and what stock trading looks like when you’re on the investment side of the equation.

What’s a Stock in the Context of a Company? 

Companies pay for their operation with two primary sources of funding. They issue bonds or notes to raise “debt” capital, or they sell shares of stock to raise “equity” capital. As an equity owner (stockholder), you acquire some rights. Most people buy common stock, which entitles them to dividends if the company declares them, to vote on matters that come up before the Board of Directors at an annual meeting, and to sell shares whenever they want over the stock exchange. (Buyers of preferred stock do not have voting rights, but in the event of liquidation, they are paid before common stockholders.)

A company that issues stock is a corporation. This distinguishes the formation of a company from the less formal partnership or sole proprietorship. A corporation’s stock experiences increases or decreases in market value based on the market’s supply and demand for shares.

This market value is based partly on the earnings record of a company, as well as on the market’s perception of its future growth potential. For example, if you buy 100 shares at $30 per share and invest $3,000, the stock’s price may rise or fall. If it falls to $28 per share, your 100 shares lose $200 in market value. If the stock’s price per share grows to $33, you have a $300 profit.

Besides market value, you are entitled to any dividends declared. This is a distribution of the company’s earnings. For example, if a company declares a dividend of $0.50 per share, your 100 shares earn you an additional $50 per year. If you paid $3,000 for a $30 stock, that is a 1.7% dividend yield ($50 ÷ $3,000).

What Does Stock Trading Look Like As an Investor? 

A stockholder is any individual who buys shares of stock in a corporation (usually common stock). Stockholders generally buy stock on an exchange such as the New York Stock Exchange. You can buy and sell shares online through a discount broker, or through an investment brokerage firm that also provides advice but charges more money per trade.

Stockholders build a portfolio of stocks through direct ownership or by purchasing shares of a mutual fund, a company that manages the funds of thousands of people and picks a portfolio of many stocks. The long-term appeal of the stock market is based on historical price appreciation. Of course, markets not only rise but may also fall. Dramatic changes in value have occurred many times through history, including some very rapid and dramatic price retreats early in 2010.

Over the long term, companies that are exceptionally well managed, competitive, and well-capitalized (through both equity and debt) have tended to out-perform the market averages. Buying stock is the preferred method people use to own a small piece of the big action.

Most investors who are just starting out, of course, probably don’t have the money to build a well-diversified portfolio of individual stocks and would be better off getting started with a selection of low-cost index mutual funds.

Stock Investment Tips

Let’s review: we’ve got the stock definition down and we know what stock trading looks like for both the company and the shareholder. Now how do you succeed in buying and selling stocks?

Here are a few investment tips to get you started:

  • Diversify your shares: Not all stocks perform as well as others, and not all industries share the same profit margins—but that’s just part of the investment game. One way to combat excessive depreciation on the stock market is to diversify your assets. Consider investing in different types of stock or even some in different industries. This way, if one asset does poorly you can make an adjustment to that share rather than having to deal with one large loss. 
  • The “right time” doesn’t exist: Plain and simple, the stock market can be risky. Many investors try to anticipate stock market changes so that they can adjust their trading strategy in their favor, but studies show that timing the market doesn’t typically translate to success. It’s important to stay informed, but the data implies that investors shouldn’t necessarily build their strategy around what they think will happen.

Takeaways: What Is Stock?

  • A stock is a monetary investment in a company that grants a shareholder certain ownership rights.
  • Companies sell stock in order to help them raise money for business operations.
  • There are two main types of stock: common stock and preferred stock.
  • Investors can buy and sell stock on the general stock exchange, but turning a profit is never guaranteed.

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