What Is Stock?
Shares of Stock
When you own shares of stock you become part owner of a company. If the company does well, the value of your stock should go up over time.
If the company does not do well, the value of your investment will decrease.
Companies issue two types of stock, common and preferred.
Common stock is the basic form of ownership in a company. People who hold common stock have a claim on the assets of a firm after those of preferred stockholders and bondholders.
Preferred stock is ownership in a company, which has a claim on the assets and earnings of a firm before those of common stockholders but after bondholders. The safety of the principal of preferred stock is greater than that of common stock.
Why does a company issue stock?
Why do investors pay good money for little pieces of paper called stock certificates?
What do investors look for?
To start with, if a company wants to raise capital (money) one of its options is to issue stock. It has other methods, such as issuing bonds or getting a loan from the bank.
But stock raises capital without creating debt, without creating a legal obligation to repay those funds.
What do the buyers of the stock -- the new owners of the company -- expect for their investment?
The popular answer, the answer many people would give is: they expect to make lots of money, they expect other people to pay them more than they paid themselves.
Well, that doesn't just happen randomly or by chance (well, maybe sometimes it does, who knows?)
The less popular, less simple answer is: shareholders -- the company's owners -- expect their investment to earn more, for the company, than other forms of investment.
If that happens, if the return on investment is high, the price tends to increase.
Who really knows? But it is true that within an industry the Price/Earnings (P/E) ratio tends to stay within a narrow range over any reasonable period of time -- measured in months or a year or so.
So if the earnings go up, the price goes up. And investors look for companies whose earnings are likely to go up.
There's a number, the accountants call it Shareholder Equity, that in some magical sense represents the amount of money the investors have invested in the company.
I say magical because while it translates to (Assets - Liabilities) there is often a lot of accounting trickery that goes into determining Assets and Liabilities.
But looking at Shareholder Equity, (and dividing that by the number of shares held to get the book value per share) if a company is able to earn, say, 1.50 on a stock whose book value is 10, that's a 15% return.
That's actually a good return these days, much better than you can get in a bank or bond, and so people might be more encouraged to buy, while sellers are anxious to hold on.
So the price might be bid up to the point where sellers might be persuaded to sell!
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