A stock, also commonly referred to as an equity or a share, is a security, which entitles its owner a proportion of the corresponding company’s assets and profits. The size of this ownership is determined by how many stocks one has relative to the total number of outstanding shares. Let us clarify that by the following example. If a person owns 100 shares in a company having 1,000 outstanding shares, that shareholder can claim 10% of that company’s assets and profits. Equity sale by a corporation is one of the most common means of raising funds for the entity’s business.
Stocks can be bought and sold on a stock exchange; less frequently they can be purchased privately. The transactions executed have to comply with governmental regulations, in order to ensure protection against fraudulence. In a historical perspective, equities have been predominant over other investments. Stocks can be traded with the majority of online brokers.
A shareholder does not own any part of a corporation’s material property
A corporation is regarded by law as a legal person. That legal person can own property, borrow, file taxes, be sued, etc., because it, as a “person”, owns its assets. For instance, material property such as the entire company office is the property of the corporation. Shareholders do now own it.
This is an important distinction to make. A corporation’s property is legally separated by the property owned by its shareholders. This separation helps to limit the liability both for the company and for the shareholder.
In the event that a corporation declares bankruptcy, its assets may go on sale by order of a judge, but the shareholders’ personal assets will not be at risk. No judge can order the sale of your shares. And vice versa, if a shareholder goes bankrupt, he cannot sell the corporation’s assets to repay his creditors.
Equity ownership and stockholders
A corporation owns the assets, and a shareholder owns shares issued by the corporation. So, if a shareholder owns, for example, 33% of a company’s shares, that person owns a third of the company. That ownership does not entitle shareholders to complete ownership of the corporation or of its assets. There is a separation of ownership and control between equity ownership and ownership by shareholders.
The shareholder has the following rights with respect to the company: voting in shareholder meetings; receiving dividends on the company’s profits; selling shares to other persons. A shareholder owning the majority of shares has a higher voting power, and thus can appoint the company’s board of directors, which allows that shareholder to indirectly control the company.
What is important for minor, or ordinary, shareholders is that each of them is entitled to a part of the corporation’s profits, in conformity with the number of shares owned by each. Stockholders with more shares are entitled to a larger part of the profits.
Common stock and preferred stock
The two main stock types are: common and preferred. The former entitles the owner to the right to vote in shareholders’ meetings and to receive dividends by the company. Preferred stock does not entitle the owner to vote; however, it gives a higher claim on the company’s assets and earnings compared to owners of common stock. Preferred stock owners have the advantage of getting dividends before common stock owners. They also have priority in cases of bankruptcy of the company.
Issuing of new shares
A company that needs additional cash can issue new shares. In such cases, the ownership and the rights of the existing shareholders are diluted (if they do not purchase any of the new offerings). Conversely, if a company has free cash, it can buy back stock. This would benefit the existing shareholders, as their shares appreciate in value.
Stocks and bonds compared
A company issues stocks to raise capital, so that it can expand its business or launch new projects. There is a difference between buying shares directly from a company and buying them from another shareholder. The first is done on the primary market, and the second type of purchasing is carried out on the secondary market.
A bond is different from a stock in many ways. Bondholders are creditors of the company. They receive interest in addition to the repayment of principal. Creditors have legal priority compared to shareholders in the event of bankruptcy. If a company has to sell assets, creditors are the first to be repaid. Shareholders are the last to receive money in such cases, and often they do not get anything if a company goes bankrupt. So investing in stocks is riskier than buying bonds.