In our last Investing Basics article, we talked about securities and what that term includes. The next few articles in this series will focus on the specific types of securities available. We’ll look at stocks, bonds, mutual funds, options, futures, and short-term savings options. Today, we’re going to talk about stocks.
What Is a Stock?
As I explained in the post about securities, a stock represents ownership. Stocks are also referred to as equities, which simply means they represent an ongoing ownership interest in a business. Each share of a company’s stock represents a piece of ownership interest in that company. When you own a share of stock, you own a part of a company.
The return you get from owning a stock comes in one of two ways: dividends or capital gains/losses. Dividends are payments the company makes to its shareholders (owners) from its earnings. If a company declares a dividend of $1.00 per share and you own 100 shares, you’ll get $100 in dividends.
Capital gains or losses result from changes in the price of the stock. If the stock’s price goes up from where you bought it, you’ll have a capital gain when you sell it. If the stock’s price goes down, you’ll have a capital loss when you sell.
Stocks are considered riskier investments than bonds because of what happens when a company liquidates or goes bankrupt. Stockholders are the last people to be paid when a company goes belly-up. Bondholders get paid before stockholders, so there’s less risk. If there’s no money left when it comes time to pay the stockholders, then they get absolutely nothing.
Finally, there are two main types of stocks: common stock and preferred stock. The biggest difference between the two is in how dividends are paid out. Common stock comes with no dividend guarantees. Preferred stock comes with a stated dividend rate (either a specific dollar amount or a percentage of the stock’s par value – the face value). Also, preferred stocks have priority over common stocks when dividends are paid. That means that dividends owed to preferred stockholders must be paid out before common stockholders receive anything. They’re a little more complicated than that, but that’s the basic difference.
In the next article, we’ll look at bonds. Make sure you sign up for free updates to Provident Planning if you want to learn more!