Chapter 1 : What are Stocks?
Topics covered in this snack-sized chapter:
A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earning.
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 to everything the company owns.
Represented by a stock certificate.
Being a shareholder of a public company does not mean that you have a say in the day-to-day running of the business.
The management of the company is supposed to increase the value of the firm for shareholders.
- If this doesn't happen, the shareholders (who own enough shares to have a material influence on the company) can vote to have the management removed.
Shareholders are entitled to a portion of the company’s profits and have a claim on assets.
- Claim on company’s assets is only relevant if it goes bankrupt.
- In case of liquidation, the shareholder receives what's left after all the creditors have been paid.
Profits are sometimes paid out in the form of dividends.
- The more shares you own, the larger the portion of the profits you get.
Another advantage of investing in stock is its limited liability.
- Even if a company of which you are a shareholder is not able to pay its debts or goes bankrupt, the maximum value you can lose is the value of your investment.
Why does a company issue stocks?
At some point, every company needs to raise money:
- By borrowing it from somebody
- By selling part of the company, which is known as issuing stock
If a company borrows by taking a loan from a bank or by issuing bonds, it is known as “debt financing.”
If a company raises money by issuing stocks, it is called “equity financing.”
Initial public offering (IPO): The first sale of a stock, issued by the private company itself.
Financing through Debt vs. Financing through Equity arrow_upward
Investing in debt investment such as a bond guarantees the return of money (the principal) along with promised interest payments.
This isn't the case with an equity investment; there are risks of the company not being successful.
There is no obligation to pay out dividends. Without dividends, an investor can make money on a stock only through its appreciation in the open market.
Appreciation: an increase in the value of an asset over time.
- The increase can occur for a number of reasons:
- Changes in inflation or interest rates
- Appreciation is the opposite of depreciation, which is a decrease over time.
The main types of stocks are:
- Small-cap, mid-cap and large-cap stocks
Ownership in a company and a claim (dividends) on a portion of profits.
Investors get one vote per share to elect the board members, who oversee the major decisions made by management.
Some degree of ownership in a company that usually doesn't come with the same voting rights (depends on the company).
Investors are usually guaranteed a fixed dividend forever.
In the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders).
Shares of fast-growing, higher-risk companies.
They offer a higher chance of higher returns and a higher chance of bankruptcy.
Shares of technology companies.
Like growth stocks, they are generally riskier than other types of companies, but they also offer a chance at very high returns.
Small-cap, mid-cap and large-cap stocks
Stocks from small, mid-size and large companies.
The "cap" is short for capitalization, which is simply the number of shares outstanding times the current price per share.
It's important to note that a company's stock can fall into more than one category. Large-cap stocks can be blue-chip stocks, growth stocks or income stocks, for example.
Small-cap stocks can be growth stocks, income stocks or tech stocks.
