What Are Stocks?


A share of stock represents partial ownership in a company, based on a finite number of shares that the company has issued. Example: ABC Corp. has issued 1 million shares and you have 100,000 of them. In this case, you own 10% of the company. This is known as your equity stake.

A stock may be either of the following:

Private: This is stock that has not been issued on an exchange like the NASDAQ or the NYSE. So to find a buyer or a seller of private stock, it can be tough — and time consuming. This is even the case with those private shares that are traded on virtual platforms like SharesPost or SecondMarket.

It is also not clear what the price of the stock is. Instead, it may have to be determined by negotiation or a third-party valuation firm or expert.

Public: And yes, this is when a stock is on an national exchange. To do this requires meeting strenuous federal and state regulations, which can cost millions every year. This is why only a relatively small number of companies are publicly traded (say 5,000 or so). In fact, if a company fails to meet the minimum requirements, then it will be delisted from the exchange. At this point, it will probably trade on the OTC Bulletin Baord. For the most part, there is not as much active trading on this market platform.

As for the price of a publicly traded stock, it is based on a bid-auction system. All in all, it is extremely easy to find a buyer or seller. The trades are usually instaneous.

Stock Valuations

Whether private or public, a stock’s value is generally based on the future earnings potential. So a company like Facebook — which has tremendous growth expectations — the valuation is hefty.

With earnings, a company can keep all or a part of them in the corporate bank account. Anything else will then be used to buyback more stock or pay a dividend. A dividend is paid on a quarterly basis and represents a certain percentage of the value of a stock. For example, Cisco currently has an annual dividend yield of 3.5%.

But early-stage companies almost always retain their earnings because the cash can be used to invest in the growth. Mature companies, on the other hand, will probably have a dividend payout.

Types of Stock

The two main types of stock include:

Common Stock: This is the most basic form of stock in a company. It will have one vote per share, such as for matters like selecting the board or agreeing to an acquisition. But there are no rights to a dividend.

For some companies, there may actually be more than one class of common stock. The typical nomenclature for this would be Class A and Class B stock. The former usually gives the shareholder more voting rights at the company’s annual meeting (this is the case with both Google and Facebook, in which the founders have retained voting control with Class A stock).

Preferred Stock: This is stock that represents ownership in a company but has more protections than common stock. For example, preferred stock may get — in a liquidation — cash before the common stockholders get anything. There may also be a required dividend payout.

All in all, it is major investors that get preferred stock, such as venture capitalists.

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Tom Taulli

Tom Taulli (Ventura, CA) is founder of the online investment company WebIPO and is the author of The Streetsmart Guide to Short Selling. 10 Illustrations

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