In our What is Investing? post we briefly looked at a stock and what it is. This post will be a deeper dive into stocks, outlining what they are and why you should be interested in them. We will also cover the different types of stocks available to an investor, and the differences between them. Finally, we will look at the overall stock market and why we need it.
What is a Stock?
Investopedia defines a stock as “a security that represents the ownership of a fraction of a corporation”. As a fractional owner of a company, the owner of the stock is entitled to a portion of the companies assets and profits equal to the proportion they own. In simple terms, if I own 1% of a company, I own 1% of the companies assets and am entitled to 1% of the companies profits.
A share is the smallest portion of a companies stock you can own. If you want to own 1% of a companies stock, you will have to buy a certain number of shares. This isn’t a hugely important distinction as the two terms are used interchangeably. The important distinction is this, if you want to buy a single unit of a company, you buy a share.
Stocks and shares are also known as equities.
Are All Shares The Same?
No, not all shares are created equal. While most investors will only ever invest in standard or common shares, there are other share types that have different entitlements. Most companies will not have multiple share options, but if they do it’s worth knowing what they are before you invest in them. Before we look at each type of share, it is worth noting the benefits of owning a share.
Dividends: A dividend is a regular payment made by the company to its shareholders, usually out of its profits.
Voting Rights: Shares may carry voting rights. This entitles the holder to vote on certain corporate matters.
Return of Capital: If a company is liquidated, shareholders may be entitled to receive money after the companies debts have been paid.
Shares may carry all of these benefits or a mixture of them. Outlined below are the different types of shares you can expect to encounter in the market. Keywords have been highlighted in bold to make it easier to compare the share classes.
- Common Shares: Also known as Ordinary Shares, these are the standard shares most people will trade in. Depending on the structure and size of the company, there may be different classes of ordinary shares. Some companies will offer Class A and Class B ordinary shares, with Class A shares usually carrying more voting rights. Common shares usually carry voting rights, are entitled to dividends and may be eligible for the return of capital.
- Preferred Shares: Or Preference Shares. Holders of preference shares are first in line when it comes to dividend payments and return of capital. Typically they do not hold voting rights. An important point to note is that the dividend payment for preferred shares is usually fixed, but it also dependant on the company realising profits in order to pay a said dividend.
- Non-Voting Shares: These are exactly what they sound like, they carry no voting rights. They are usually eligible for dividend payments and return of capital.
- Deferred Ordinary Shares: Usually carry voting rights. They are also entitled to return of capital and dividends, but only after all other shares have received their entitlement. You can think of deferred shares as the opposite of preferred shares.
- Redeemable Shares: Give the company issuing the shares the option to buy back the shares sometime in the future. The buyback period may be defined but it does not have to be. Redeemable shares usually carry the same voting rights along with the same dividend and return of capital entitlements as common shares.
- Redeemable Preference Shares: A hybrid of both redeemable and preference shares. Carries all of the same limitations and benefits of a preference share, but with a buyback option.
As mentioned previously, most retail investors will only be concerned with common shares as these are the most widely available shares. It is important to bear in mind the other share types when purchasing shares. The last thing you want is a deferred ordinary share if your goal is dividend income.
What Is The Stock Market?
The stock market is exactly what it sounds like, a place to buy and sell stocks. Without the stock market, investors would be stuck in illiquid positions that would be extremely difficult to sell. Stock exchanges operate all over the world which allows companies to list their shares for sale. Some of the major ones are the New York Stock Exchange (NYSE), the London Stock Exchange (LSE) and the Tokyo Stock Exchange (TYO). Brokers and traders can buy and sell anything that is listed on the exchange, from stocks to bonds. Through brokers, investors can buy stocks listed on exchanges in other countries.
In the past the stock exchanges acted as places where stocks were physically bought and sold, naturally, this has evolved into electronic trading. It has never been easier to buy and sell stocks. There are an endless amount of online brokers to choose from but not all are created equal. As with any industry, there are good companies and bad companies. When buying stocks it is not only important to do your research on the company itself, but on the stockbroker, you are using.
The Stoic Trader