Shares and stocks
Stock (reference), share (reference)
Shares of stock
Imagine that you make a decision to start a business. You decide that you need $50.000 to get the business off the ground. This money represents original capital you will invest into a business and it’s called the stock or capital stock.
You establish a company and divide it into 1000 pieces or shares of stock. Then you price each share at $50 ($50 x 1000 = $50.000). If you manage to sell all of the shares, you get $50.000 you need.
Those, who buy shares of your company (shareholders), get a share of the ownership of the business. They get the right to vote in shareholder meetings and are entitled for a part of company’s profits.
If a business performs well and earns $25.000 after taxation for the first year, each share is entitled to a thousandth part of the profit, or $25 earnings per share (or briefly EPS). You may call a shareholder meeting and decide how to deal with company’s profits. It may be used to pay cash dividends to shareholders, to reduce company’s debt or to expand the business.
Note. The term “stocks” (in the plural form) is often used as a synonym to shares. Similarly, the term “stockholders” is a synonym to shareholders.
Private limited companies
If a group of people decide to start a business, in the most cases they first form a private limited company. Limited company is a legal entity, which are separate from its owners. In case of bankruptcy, company’s assets are sold (liquidated) to pay company’s debts. If the cash received from selling assets don’t cover company’s debts, creditors just don’t get all their money back.
Public limited companies (PLC)
If business goes up, a company can apply to a stock exchange to become a public limited company (or a listed company in US). A public company has permission to offer its securities (shares, bonds, etc.) for sale to the public. Those securities may be traded through a stock exchange or over the counter (OTC).
Floating a company
Process of issuing shares for the first time is called “floating a company”. Act of selling stock by a private company to the public for the first time is called an initial public offering (IPO).
Underwriting the issue
In general, companies use an investment bank to underwrite the issue. It means that underwriter guarantees to buy all securities on a certain day at an agreed price, in case if they can’t be sold to the general public.
Secondary market
After stocks first being issued, they could be then resold and bought on the secondary market. As number of shares is limited, there exists certain supply and demand for them. Supply-demand ratio determines price per share.
Stock market
Stock market is an auction. Let’s demonstrate in on example. For instance, current stock price of IBM is $50 per share. If someone wants to sell their shares of IBM and there are no buyers at $50, the price would have to decrease until someone enters the auction and places a buy order. If investors anticipate faster growth of IBM profits as compared to other companies, stock price of IBM would increase, affected by increased demand.
Stocks vs. Bonds (Equity vs. Debt)
Stocks are equity, whereas bonds are debt. When buying equity (shares of stock), one becomes a partial owner of a business, which comes with voting rights and a share in company’s profits. By purchasing debt (bonds), one becomes a creditor. Bondholders are entitled only to a principal plus interest (generally fixed), but they have a higher claim on company’s assets, than stockholders. It means that if company goes bankrupt, creditors will get paid before shareholders.