You have often heard the word stock being mentioned on the news, in conversations, or on the internet. It is used in relation to many other terms, some of which are stock market, investing and trading, as well as company growth. Understanding stocks and types of stocks, can help you in the future by learning how to invest in companies and their stocks.
So let us start by asking the main question “what is a stock? And why is it so much related to investors, corporations, and even the economy?”
Grasping the concept of stock through an analogy
Let’s give an analogy to stocks in order to make it easier for you to understand.
Imagine that you are at a carnival, and you have bought a ticket for a rollercoaster ride. At this carnival, the ticket prices of the rides quickly fluctuate because of the demand for rides and other factors. Suppose you bought the ticket for a rollercoaster ride at a certain moment for $2 and hold on to it. A few moments later, the price of the rollercoaster ride goes up to $3. This increases the value of your ticket by another dollar.
As more time passes, more and more people show up to demand rollercoaster rides, which drive the price of the ticket up to $5. So now you are making a $3 profit if you sell your ticket to someone else. However, you decide to hold the ticket till late at night hoping to make more profit. Unfortunately, people are not buying tickets for a rollercoaster ride anymore because maybe the rollercoaster ride did not get excellent reviews or is not exciting as people expected. The prices of the rollercoaster’s tickets drop to $1. And now you are at a $1 loss just by holding your ticket for the rollercoaster ride.
This is an example of how stocks work in the stock market. In this example, shares are like the tickets – while the rollercoaster ride is like a company. The carnival itself can be compared to the stock market or stock exchange where you buy stocks. Just like how each ride has its own tickets in the carnival – similarly, each company has its own stock that is sold on the stock exchange.
What is the definition of stock?
So now that you have a general sense of what it is, let’s give you a proper definition. A stock is known as equity, which gives you ownership of a fraction of a company or corporation. The company puts shares out in the stock exchange in order to generate capital and funds through public investment. Remember, the term share means one unit of stock.
You buy and hold on to shares, hoping to gain profit in a future time period. If the company performs well, and people start demanding more shares, the stock price will go up. However, the company’s performance is not the only reason for an increase in the price. Its performance can increase due to external factors as well.
The opposite is also true. For any certain reason, the price can also recognize loss after some time. This is just like the loss you incurred in the analogy while holding the rollercoaster ticket at night when its price dropped due to less demand. Now in the real scenario, low stock performance can lead you to face loss through your shares of the company.
What is stock ownership?
After listening to this definition, you might ask, “Do I now own a part of the company if I own a portion of its stock?”
To answer this, let’s use the carnival-ticket analogy again before we give the technical explanation. When you buy the ticket for the rollercoaster ride, you do not own the rollercoaster itself in any way. What you do own is the right to enjoy the ride, which is the service that the owner of the rollercoaster has set for you. What you can only do as a ticket-holder is use the tickets as you please, but you cannot own the rollercoaster or parts of it as assets.
So similarly if you own shares or a portion of a company’s stock, for example, let’s say you own 20% of the stock. It does not mean that you now own 20% of the company or its assets. What it means instead is that you can only earn the profit from the company which you gain from your 20% share of the stock. In short, what you are is a shareholder and not a company owner.
What rights are stock owners entitled to
The differentiation is legally important too because the internal control and functioning of the company’s assets are done only by the management–while the stockholders only have certain rights in the company. These certain rights include the right to vote in shareholder’s meetings, accept dividends from the company (depending on type of stocks) and sell your shares to whomever you wish.
The dividend is the share of the profit that a company earns through its own business model, which it then divides among the stockholders. However, corporations can decide to use this profit of theirs to reinvest back into the company’s growth instead of dividing it among shareholders.
There is, however, one way to indirectly exercise control of a company by being a stock owner. If you own a majority of shares, then your influence on the company can indirectly increase. You gain majority voting power in shareholder meetings and decisions. With this power, you can choose to appoint certain members of the board of directors during a shareholder meeting. This can change the focus and mission of the company to a certain extent.
What are the types of stocks?
Now let’s talk about the types of stocks out there. There are vast types, but the ways these types are divided are based on the following categorical reasons;
The first-way stocks are categorized is based on the different levels of rights and ownership they provide to stockholders. The second way stocks are categorized is based on the types of industry the companies are based in. If a company is an electric automobile marker, then its stock would be considered EV stock. The third way to categorize is by looking at the total worth of all the shares. This is known as the market capitalization of a company or stock. This consists of small-cap, mid-cap, and large-cap stocks. Finally, stocks are categorized based on the different characteristics and trends of the companies, their shares as well as the trends in the overall market economy.