Owning A Share Of Stock: What Does It Really Mean?
Many people recognize that owning a stock means buying a small percentage of ownership in a company. However, some new investors have misconceptions about what owning stock entails. Most of these misconceptions stem from a lack of knowledge of the amount of ownership that each share of stock represents.
Understanding stocks is vital to effective investing because stocks play a crucial role in developing a balanced investment portfolio. So, before you purchase stock, here’s what you should know about what it really means to own a share of stock.
What Are Stocks?
Put simply, stocks are units of ownership in a company. Stocks are sold in units known as shares or equity. There are different kinds of shares, but when people talk about purchasing shares in a company, they usually refer to common stock.
To raise capital for funding their operations, private companies sell shares of stock, inviting investors to purchase a fractional ownership interest in the company. They do so by conducting what’s known as an initial public offering (IPO). When you hear about a company “going public,” that means that the company is conducting an IPO to make shares of their stock available for purchase via public markets.
During the IPO, the company and its advisors set an IPO price for their stock shares. Then, the funds raised by investors purchasing those shares go directly to the company. Once the initial offering is finished, shares are traded on the secondary market, or the stock market, where prices rise and fall depending on multiple factors.
The Benefits of Owning Shares of Stock
When you purchase shares of stock in a company, certain privileges are conferred to you, depending on what kind of shares you’ve bought. These privilege may include:
- The right to vote at the company’s annual shareholder meeting.
- A percentage of the company’s profits, or dividends.
- Capital appreciation, meaning that when the company’s stock price increases, your shares increase in value.
Risks Involved in Owning Share of Stock
Of course, like many activities, owning shares of stock comes with both benefits and risks. The risks that you take when owning stock include:
- There’s no guarantee that companies will pay out a dividend every year. Sometimes, a company’s profitability doesn’t allow dividends to be paid out. Sometimes, the company will reinvest the excess profits instead of paying them out.
- While an increase in a company’s stock price often means an increase in the value of your share, if the company’s stock price decreases, your shares will decrease in value.
- If you own common stock, you are last in line to receive dividends from the company’s profits after debt-holders, creditors, and preferred stock owners. So by the time it gets to you, there may not be any dividends left to pay. In addition, if the company goes bankrupt, common stock owners are the last in line to receive the proceeds.
Misconceptions About Owning Shares of Stock
There is a lot of misinformation floating around about what it means to own shares of stock in a company. While the concept of owning shares sounds straightforward, it’s more complex than people realize, which leads to several misconceptions.
First off, despite what movies and television would have you believe, owning the majority of shares in a company does not allow you to hire or fire executives or make decisions about day-to-day operations at the company. Owning stock means that you’ve placed your faith in the company’s management. If you’re unhappy about the direction management has taken, your only recourse is to sell your stock, not go to the company with your shares and demand a change.
Another misconception is that owning stock entitles you to discounted goods and services from the company. While some exceptions are to be made for certain companies and their shareholders, owning shares typically only entitles you to a percentage of the company’s profits.
Finally, your ownership in the business is strictly from a financial standpoint. Owning stocks does not give you a claim over the physical company or its property.
Why Own Shares of Stock?
Investors use stocks to expand their portfolios, grow their savings, and plan for long-term financial goals like your retirement. As stock prices go up, so do your savings. While purchasing stocks may involve some risk, it remains one of the best ways to diversify an investment portfolio. Investors purchase shares of stocks in different companies to mitigate risk and ensure profits by enjoying gains in thriving sectors while offsetting the losses from others.
If you’re the kind of investor who can handle a bit of risk, is looking to achieve long-term goals, and knows how to read the market to potentially offset losses, buying stocks is a good option for you. However, if you want to diversify your portfolio, make money with minimal risk, or desire an option with professional management, you should look to other avenues, such as mutual funds, bonds, or annuities.