What is a stock, and how do I invest?
Every company originates from an idea and this idea usually arises from the need to solve a certain problem. For instance, you have identified that customers are not able to access organic fresh produce easily. To solve the problem, you and a few friends co-found a start-up that delivers organic fresh produce using modern means. Such modern means include drones, robotic vehicles, delivery cyclists and delivery vans.
The problem is without financial backing, the idea will hit a dead end. As co-founders, you will start by contributing capital. If you are three co-founders, the first co-founder may contribute 40%, the second may contribute 35% while the third may contribute 25%.
This forms the ownership of the company.
What is a stock?
This is a type of security that represents a share or ownership of a private or public corporation. It can also be defined as an asset that accords stockholders a share of the company. Also referred to as equity, it represents a claim on the company’s earnings and assets.
Let’s assume a corporation issued 10,000 shares and you own 1000 shares, it means you will have a share of the company’s earnings if they decide to pay out. If the company made $1 Million and they decide to pay out to shareholders, as the owner of 1,000 shares or 1/10, you will earn $100,000.
As you already know, corporations are special entities treated as legal persons. As a result, they can file taxes, own property, borrow funds and even be sued or sue others. With this in mind, you ought to know that stock holders don’t own corporations but they do own shares/stock issued by the corporation.
You may be wondering – why the distinction between corporations and stockholders? Well, the property owned by the corporation is separate from the stockholders property. This limits the liability of both entities – corporation and stockholders. In case the corporation goes bankrupt, your personal assets will not be at risk even though the assets of the corporation will be sold to recover debts. Simply put, the court cannot force you to sell your stock.
Types of Stock
There are two types of stocks namely:
- Common stock
- Preferred stock
As a security that represents a share of a corporation, owners of Common stock can exercise their rights to elect the board of directors and even vote on corporate policy. Located at the foot of the priority ladder of ownership structure, common stockholders have rights to the company’s assets in case of liquidation. The problem is this rights can only be exercised after bondholders, preferred shareholders and debt holders have been paid fully.
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Stockholders of Preferred stock have a higher claim on the company’s assets and its earnings than common stockholders. They also have their dividends paid out before common stockholders are paid dividends. The problem is preferred stockholders do not carry any voting rights like common stock holders. Simply put, they cannot elect the board of directors.
Why do companies issue stock?
Every corporation has a goal of expanding its operations not only from one city to another but from the country where its headquarters are to other nations around the world. To do so, the company needs financing. There are two ways private companies can seek financing. One is to issue bonds and the other is to issue stock.
The first offering of stock is called an Initial Public Offering and this transitions the private company into a public company. During an Initial Public Offering, individuals and business are invited to purchase stock allowing the company to raise funds.
These funds are used to:
- Develop new products
- Hire more employees
- Decrease debt
- Place a value on the company
- Buy advanced equipment
- Expand into new markets and regions
- Enlarge current facilities or build new ones.
Why do investors buy stock?
Investors buy stock for capital appreciation. Simply put, they want their money to grow in value over a certain period of time. Capital growth is the increase in value of an investment over time. It is measured by calculating the difference between current market value and its purchase price at the time the investment in this case stock, was bought.
Earn an income
One of the main objectives of starting a company is to make profits. This usually arises from the sale of products and services. Companies do issue a portion of their earnings to their investors which can be termed as an income. For common stock holders, they generally receive dividends on a quarterly basis.
Ability to vote
Common stockholders have voting rights which allows them to elect the board of directors and vote on company policy. These voting rights are equal to the number of shares owned. As a result, they have the chance of influencing the direction of the company. With the board of directors in place, they can decide whether or not dividends will be paid and how much will be paid.