What is a stock?

A stock certifies an investor’s share of beneficial ownership in a company.  Beneficial owners are entitled to protection from liability for any of the company’s actions while receiving dividend payments from the company (at the pleasure of the company), voting on issues of corporate governance, and either selling their shares in the stock market or sharing proceeds from a liquidation of the company.

Each share is equally valued in proportion to the total number of outstanding shares issued by the company. Capitalists initially obtain shares in a private market known as the primary market and can chose to sell their shares to individual investors in a public market known as the secondary market. The secondary market is better known as the Stock market.

Here’s an example of an old fashioned stock certificate:

stockcertificate

Stock certificates were printed and distributed to shareholders who then assumed responsibility for safekeeping and transferring the certificate. The loss or destruction of a certificate meant the loss of an investment and stock transfers were a time-consuming, administrative process. Owners generally held their certificate for a long time in order to earn a satisfactory profit from dividends and growth of the stock’s price. Speed trading was unheard of before today’s methods of electronic bookkeeping and online trading platforms. Now, a responsible custodian maintains all records of stock ownership on behalf of the investor.  Confirmation messages and periodic statements provided by the investor’s brokerage firm serve as proof of ownership.

The reason that investors buy stock is to earn a profit by accumulating dividends and selling shares. Investors can protect their interest by voting on corporate matters such as board membership and executive compensation. In case the company files for bankruptcy, the proceeds from liquidation are theoretically distributed equally among stock holders according to the number of shares they own. In fact, the court-ordered company must first pay its debts, which means that corporate bondholders have priority over stockholders in receiving repayments of debt. Then owners of preferred stock have priority over common stock holders in receiving the residual funds.

Preferred stock is a hybrid form of bond and stock. The bond portion represents corporate debt to be repaid with guaranteed fixed-dividends and the stock portion represents an equity opportunity to earn capital gains without the privilege of voting rights.  Common stock represents an equity opportunity without guaranteed dividends but with voting rights. Preferred shareholders typically earn more dividends and common shareholders typically earn more capital gains.

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