Stock Basics - Engineer Your Finances

The Definition of a Stock

Simply put, a stock is a share in the ownership of a company. Stocks represent claims on the company’s assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing.

Having Stock Means Being a Part Business Owner

Holding a company’s stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company’s earnings as well as any voting rights attached to the stock.

A stock is historically represented by a stock certificate. This is a fancy piece of paper that is proof of your ownership. In today’s computer age, most of the time you won’t use or see this document because your brokerage keeps these records electronically. This is done to make the shares easier to trade and manage. You still own the shares, they are just in digital form. If you really want a paper stock certificate, you can order them.

Having Stock Means Getting a Cut Of the Profits

So why is owning shares such a big deal? In a word, profit. The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on its assets. Profits are sometimes paid out in the form of dividends or other special payments. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you’ll receive what’s left after all the creditors have been paid. This last point is worth repeating: the importance of stock ownership is your claim on profits and assets. Without this, the stock would just a worthless fiction.

Shareholders Get to Vote

The management of the company is supposed to increase the value of the firm for shareholders. If this doesn’t happen, the shareholders can vote to have the management removed, at least in theory. In reality, individual investors often don’t own enough shares to have a material influence on the company. In practice only large institutional investors, high-net worth individuals or management itself control major companies. In terms of the amount of shares owned compared to hedge funds, small investors are literally like fleas on the back of a rhinoceros.

Stocks Usually Have Limited Liability

Another extremely important feature of stocks is limited liability, which means that, as an owner of a stock, you are not personally liable if the company is not able to pay its debts. Other companies such as partnerships are set up so that if the partnership goes bankrupt the creditors can come after the partners (shareholders) personally and seize their assets. Owning stock means you have limited liability in that the maximum value you can lose is the value of your investment – your personal assets are protected, thus providing you some limited protections in the event of a worst case scenario.

Risks of Owing Stocks

Stocks can be super risky. There are many, many examples of people who have lost everything in the stock market. There are a number of sources of risk for stocks, the sum total of which are hard for even professional investors to calculate. These include: political risk, stock market risk, company management risk, risks related to the weather, commodities & commodities pricing risk, risk related to investor sentiment as well as plain old bad luck.

There are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends even for those firms that have traditionally given them. Without dividends, an investor has fewer options for making money with their shares – they can be used as collateral for a loan or they may be sold for a profit – but in general you have fewer options once dividends are taken away.

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