Investment basics: what is a stock?

I thought it was funny how you can partially own a company without possessing any material part. Like, I own Apple stock, but I don’t even own the company’s stapler or toilet paper, much less one of their popular iPads or Macbooks. Holding a stock doesn’t mean I’m entitled to anything valuable necessarily. It’s an interesting concept.

toilet-paper-no

It confused me for many years what a stock is, and even today I can’t say that I fully understand what it is yet, but let me give it a try, and correct me if/where I’m wrong.

Step back for a moment. What is a stock outside of the finance world? Walmart is out of stock for the popular Nokia Lumia 521. The iPhone 5 is in stock at AT&T store. In the history of human commerce, a stock usually represents an inventory of a shop. So think of a finance stock, aka, capital stock, as some form of an inventory. In the past, an owner of a store would have the claim to a part of the store inventory. A corporation today is a lot more complex than just a store with inventory, so the concept of stock is abstract. But imagine that the company can be divided up into small pieces of equal values, then the company is literally an inventory of these small pieces. And these small pieces happen to be called shares.

Think of stock as an inventory, and a share as a unit.
Think of stock as an inventory, and a share as a unit.

Stock and shares do not have physical shapes: they are abstract concepts. I guess if you could somehow merge every single employee, tool, patent, building, etc. that Apple owns into a homogeneous pie, then cut the pie into 1 billion exactly equal slices, and call each slice a share, then these shares would have some physical shape. But I realize we’re not in Big Bang Theory.

your head will explode

Just about every single company has a stock, and a stock can be divided into shares or not. If a company is owned by multiple people, the company may issue shares as distribution of ownership. Say Hiep’s Finance is a corporation that is owned by Richard and Marco. Hiep’s Finance issues 2 shares. Richard owns 1 share, and Marco owns the other. So they have equal ownership of the company. If, on the other hand, Richard actually invests more in the company and therefore claims more ownership, then Hiep’s Finance should issue a larger number of shares than that. So Hiep’s Finance issues 1000 shares. Richard feels that he should own 70% of the company, so he has 700 shares, and Marco has the rest.

So that’s what stock and shares mean. But why do people own stocks? Well, supposedly, when you own a company’s stock, you become a shareholder and can participate in the company’s shareholder meetings and vote on the company’s issues. In addition, you’ll be entitled to some portion of the profits, as well as losses, that the company makes. When the profit is distributed to you, the distribution to you is called a dividend.

This is what I don’t understand about stocks: why do people buy them? You likely own too small a portion of the company for your voice to be heard. I don’t think my companies really care about me if I own 0.0001% of it. It’s the guy that owns 50%, or the next guy that owns 1%, that matters. How about dividends? Well, most companies don’t pay dividends at all! So if you don’t gain anything from owning a company, why you should own it then? Why not spend the money on world travels instead?

I have found one possible explanation, bit this one pertains to special cases. If you hold shares of a company that gets acquired by another company, say Facebook acquiring Instagram, then the acquiring company has to pay the shareholders for the right to own their company. In this situation the value of the shares is realized.

What about other cases? What if the company whose stock you own does not get purchased by another company? Why do people still buy the stock? At the moment, I don’t have an answer to this question.

question-mark

Hopefully as I venture deeper into the world of investing I will eventually find out why people buy stocks. But for a learning investor, knowing that a share is a piece of ownership is enough to explain a lot of phenomena going on in the world of finance, such as the movements of the stock market. More on that later.

Best,
Richard (Hiep Tran)

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