Breaking Down the Revealing Secrets to a Stock

5 minutes

what-is-a-stock

October: This is one of the peculiarly
dangerous months to speculate in stocks.
The others are July, January, September,
April, November, May, March, June,
December, August, and February.

Samuel Langhorne Clemens,
better known by his pen name Mark Twain

What is a stock?

A stock is a kind of security to indicates that a person owns a piece of that business. It also signifies that there is ownership of the business’ assets and earnings.

Business’ that are set up as corporations have stock issued to show ownership in the business. The articles of incorporation that a business has to setup defines the number of shares authorized to be issued for the business. These are the shares that can be offered to the public at the board of directors consent.

Stocks used to be issued in paper form but now they are all handled electronically. It is fun once in a while to see the old stocks. It brings a feeling of nostalgia.

Public companies are the only ones that can issue stocks shares for ownership in their business. Think of Target, Walmart and so on. Companies can go from public to private as well such as Petsmart recently. In a case like this, the public shares all have to be liquidated so that ownership can return to the private party.

Private companies such as Uber, the ride-sharing business can go public or offer shares in their company. This is called an IPO or initial public offering. These usually receive a lot of hype and tend to be very expensive. I would counsel you to avoid these if at all possible. More on this later.

Shares are stock in the company. So when you own 100 shares of Amazon you own 100 stocks of the company. Once you have purchased shares of a company you are considered a shareholder and these shares give you certain rights of ownership.

Why companies issue stock.

Reason number one for a company to issue stock is to raise MONEY!! When a company decides to sell shares of its company, those shares have a value that someone will decide upon. When those shares are purchased it generates capital for said company.

The company can decide to use that capital for many different purposes, among them are:

  • pay off debt
  • launching a new product
  • expanding into new markets
  • enlarging facilities or building new ones

Keep in mind that established companies can decide to issue new shares of stock to achieve the same results. It doesn’t just happen when a company goes public.

Again to reiterate the number one reason to issue new shares of stock is to raise MONEY!

Why people buy/sell stock.
  • capital appreciation which occurs when a stock rises in price
  • dividend payments, which comes when a company pays a shareholder back from its earnings
  • ability to vote shares and influence the company

These are among some of the reasons why someone would buy or sell a stock.

One big reason someone would sell a stock would be the value of the company has declined. Notice I said value, not price. To quote Warren Buffet “Price is what you pay, the value is what you get.” Remember that the market is a voting machine at first and then a value machine over time.

Another reason you would buy a stock would be that the value has increased while the price has fallen for some reason. Maybe the company has fallen out of favor or it is in an overlooked sector. This is a terrific opportunity to buy at this point as the value you are looking for is there and the price is attractive such that you will be able to make money over the long haul.

Common Stock

Common stock is what most retail investors purchase when the buy a share of stock. This purchase grants you rights to dividends if issued. It also includes earnings growth and voting rights.

When you purchase shares of the company you are essentially buying equity in that company. Why is this important? Because in the event of a liquidation or bankruptcy of the company, the common stock shareholder would be one of the last creditors to be paid.

Common stocks are often divided into two classes of stock such as class A and class B. One such company that leaps to mind is Berkshire Hathaway which has class A and B shares. One share of class A sells for $215,860!! Class B is much more affordable at $143.87, seems like such a bargain comparatively.

Typically class A shares will have voting rights while class B will not. All shareholders have the responsibility to vote for the board of directors, CFO and CEO.

Preferred Stock

A preferred stock is a class of ownership in a corporation that has a higher claim on the companies assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before the dividends of the common shareholders. Preferred shares usually do not carry voting rights.

Another note about dividends for preferred shares. They generally have more yield than the common shares and they also can be paid monthly or quarterly.

The makeup of preferred stocks is different in that it comprises partly debt, which pays a fixed dividend. It also includes equity, which has the potential to increase in price. The details of each preferred stock can differ depending on the issuing company.

Preferred shareholders have a prior claim on the companies assets if it is liquidated, though they remain behind bondholders. The are considered equity but they straddle between stocks and bonds. They are considered a hybrid stock.

A downside of preferred for retail investors would be that they have less potential to increase in price than common stock. They usually trade within a few dollars of their issuing price. Which is $25 or par for preferred stock.

They can trade at a discount or premium which can depend on the creditworthiness of the company and the details of the issue.

Due to tax advantages that institutions enjoy with preferred shares, they are usually the ones that would purchase these shares. Common shareholders are less likely to buy these types of shares as they don’t enjoy the tax advantages.

Large companies such as General Electric, Bank of America or Verizon may issue preferred shares to raise capital for projects that they may not have the cash to pay for.

4 categories that common stock or preferred may fall into
  • Growth stocks have earnings growing at a faster rate than the market average. They usually don’t pay dividends and investors hope to gain from capital appreciation. A tech stock or biotech stock would fall into this category.
  • Income stocks pay dividends consistently, like a dividend aristocrat. Investors buy them for the income they generate. Great for retirement income. A company like Coke would fall into this category.
  • Value stocks are stocks that have fallen out of favor but have favorable financials. Because the price has fallen they are cheaper and a great investment. People buy these stocks in the hope that they will appreciate with time. They can be growth or income stocks.
  • Blue-chip stocks are typically very large companies like IBM, Apple, Nike and so on. They are well-known companies that usually pay a dividend.

Stocks can also be categorized by their market capitalization or size of the company. There are large-cap, mid-cap and small-cap. There is also micro-cap for the really small companies.

Finally, there is penny stocks. They have little to no earnings and don’t pay dividends. The highly speculative.

Final thoughts

The stock market is a strange, confusing place. We are going to help make it a little clearer one step at a time. This post we talked about what stock is and where they come from. The biggest thing to remember that a share of stock is a part of the company.

So when you buy a stock you are becoming a company owner. This makes it pretty simple. Now, what type of company do you want to buy? That is a little more complicated but we will get to that.

Studies have shown that investing in the stock market is one of the best ways to grow your wealth. So learning more about the market and how it works will work to your advantage. Just keep in mind that when you buy a stock you are a shareholder in that company and you have rights as a shareholder.

You can also receive dividends as a shareholder which can help increase your wealth as well as the increase in price, or capital appreciation.

Please share this if you feel like it could be of benefit to someone you know. Let me know what you think of stocks now.

Thanks for taking the time to read this post and until next time take care.

 

 

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