What are stocks?
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What are stocks?
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One part of investing in stocks and other financial markets is the use of many, many terms that all refer to the same thing. This is very confusing for a starting investor. Many websites and other sources use the wrong terms in the wrong context. To get things clear right from the beginning:
Stocks, equity and shares refer to the same thing. They all refer to the ownership of a company and can be used interchangeably. This might be very confusing because one website might refer to stocks, the other uses shares and another site uses equity. While they all refer to the same thing, it’s the context these words are used in that matters most:
- “Stock” is usually used to describe ownership in a company. For example, you own stock from Apple.
- “Stocks” is usually used to describe ownership in multiple companies. For example, you own stocks from Apple, Microsoft and American Airlines.
- “Shares” refers to the amount of units of a stock. For example, you own 100 shares of Apple, not 100 stocks.
- “Equity” usually refers to the total ownership in a company. For example, when a company has 100.000 shares and you own 10.000, you got a 10% equity stake in that company.
But in the end, equity is just a certain amount of shares and stocks are measured in shares. They are all the same thing, just used in another context. So it depends on the source of information if the context is correctly applied.
While we're at it, you will also encounter the word “security” a lot when reading about stocks or bonds. A security is a general term used for financial instruments that have ownership or debt in a company that has value and can be bought or sold. A stock represents ownership so a stock can be called a security. A bond represents debt, so a bond is also called a security. There are three types of securities:
- Equity securities (shares)
- Debt securities (bonds/mortgage/loans)
- Derivative securities (options,futures, CFDs)
You’ll learn more about bonds and derivatives in later chapters. For now you just need to know that a stock is a type of security.
3.1 Why do companies sell stocks?
Why would a company issue shares to the public?
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It’s important to understand that you do not actually own everything the company possesses when you buy their shares. You own the shares of that company. You do have a stake in the company's equity but the real corporate property is legally separated.
For example, all the computers used in the company are owned by the “company” and not by the shareholders. This is important to know because of the liability. For example, if you go bankrupt for whatever reason, you can’t sell the computers of the company to pay creditors just because you are a shareholder. And the same applies for the company if they go bankrupt. They can’t quickly sell your shares because they need money.
3.3 Two types of stocks
There are two types of stocks:
- Common stocks
- Preferred stocks
The main difference between common and preferred stocks are certain rights and features. For example, preferred stockholders hold an advantage over dividend payments. They receive dividends before common stockholders do. Preferred shareholders also get a predetermined amount of dividend at a predetermined interval. The dividend payment might be lower than common stocks but is more steady. In some cases, preferred stock holders get dividend payments and common stocks holders get none.
Preferred stockholders are eligible for payback of leftovers before common stockholders when a company gets liquidated (the company goes bankrupt / stops existing). While on the other hand common stockholders have voting rights where preferred stockholders do not. Preferred stocks act more like a hybrid combination of stocks and bonds (equity and debt). You’ll learn more about bonds, equity and debt in the next chapters.
Preferred stocks have a call option. A call option gives the issuer (the company) the right to redeem or reclaim the shares at a certain price on a certain date. Basically meaning you have to sell back the shares to the company. Common stocks don't have a call option.
An overview of differences:
|Feature / rights||Common stock||Preferred stock|
|Dividends||Variable amount||Fixed amount|
|Dividend payment order||Last||First|
|Claim on leftovers after company liquidation||Last||Second Last|
Issueing preferred stock is often the last resort for a company to raise additional money due to taxes. They will issue common stocks and bonds first. Dividends paid to preferred stockholders are paid with profits after tax. These expenses are not deductible while bonds are deductible. Most of the time preferred stocks are bought by institutional investors. Institutional investors are large institutions with hundreds of millions or billions of cash like banks and hedge funds. As a traditional investor you will most likely always buy common stocks. But preferred shares are getting more attraction by investors over the last few years.
An overview of historical returns and volatility over the years between preferred stocks and common stocks (equity):
Source: Bloomberg, RBC Dominion Securities, Inc.
What is volatility?
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Chapters: The Ultimate Investing Guide
- 1. Intro2. What is investing?3. What are stocks?4. Types of stocks5. Why buy stocks?6. How to buy stocks7. Store stocks8. Stock splits9. Stock quests10. What are bonds?11. Secured bonds and maturity12. How do bonds work?13. Credit rating14. Treasury bonds15. Corporate bonds16. Municipal bonds17. Agency bonds18. Bond quests19. Mutual funds20. Mutual funds earnings21. ETFs22. Why ETFs23. Index funds24. Hedge funds25. Derivatives26. Commodities27. Indices28. Overview29. Determine company value30. IPOs31. Penny stocks32. Dividends33. Financial health34. Profitability35. Operating efficiency36. Liquidity37. Solvency38. Market Evaluation39. Not only numbers40. Investing portfolio considerations41. Creating portfolio42. Buy/Sell Strategy43. Broker44. Emotions45. Final steps46. Key Concepts