Ever wondered what a “stock” really is? It’s okay if you’re not sure, as many people might not fully understand it either. At MyMoneyDesign, I always stress the importance of knowing where you’re putting your money when you invest. So, let’s dive into the basics of stocks.
A stock represents a piece of ownership in a company. When a company needs funds but doesn’t want to borrow (taking on debt), it sells parts of its ownership as shares. Owning these shares means you have equity in the company.
Why do companies issue stocks? Imagine I wanted to raise money for MyMoneyDesign. Instead of borrowing $10,000 from a bank and going into debt, I could sell 10 shares of my blog to you and nine other people for $100 each (10 shares x 10 people x $100 = $10,000).
You’d buy these shares hoping to make money. If MyMoneyDesign becomes more popular and starts making more money, a couple of things might happen:
– The value of your shares might increase (this is called capital appreciation), giving you the chance to sell at a higher price and make a profit.
– You might get a small part of the profits through quarterly payments called dividends.
Being a shareholder also gives you certain rights. For each share you own, you typically get a vote in the company’s major decisions, like electing board members. If you own a lot of shares (often millions), you could even become a majority shareholder and have significant control over the company.
Additionally, if the company goes out of business, you’d be entitled to a share of the remaining assets, assuming there are any.
The value of a stock is determined by what someone else is willing to pay for it. Thankfully, the stock market is where this buying and selling happen constantly. When a company first offers stocks, their initial price is set by the company and the broker handling the offering. But then, the price is influenced by supply and demand dynamics in the market.
For instance, if MyMoneyDesign has a great financial status or is about to launch something exciting, demand could push the stock price up to $110. Conversely, if a competitor outshines us, the stock value might drop to $90, even if our company’s health is still good.
While a company’s intrinsic factors, like book value, affect its stock price, the market ultimately determines what price you see on the ticker.
Once a stock is in the market, the issuing company can’t control its future transactions. The shares can be bought and sold multiple times for different prices. If MyMoneyDesign’s share price rises from $100 to $150 and you sell, you get the $50 profit, not MyMoneyDesign!
So why does MyMoneyDesign care about its stock price? Because a higher share price means we can issue new shares at that higher price, raising more money. If shares plummet to $0, no one would want to buy them, and the company couldn’t raise new funds.
The Board of Directors answers to the shareholders, so they, along with company executives, work to keep the stock profitable.
We’ll delve into stock valuation techniques in a future post. I hope this introduction helped you understand what stocks are and how they work.
1) What Does “Stocks Return 8 Percent Each Year” Actually Mean?
2) How to Buy an Index Fund
3) Why I Finally Sold My Apple Stock
