Understanding the Basics of Owning Stock
A reader wrote in with a good question recently:
What does it mean to own stock in a company? Do you own a piece of that company? Are you just gambling that you think a company’s value will go up or down? I guess I don’t really understand the stock market.
Let’s take a simple walk through what a stock is, what owning one means, and why someone would want to own a share of stock in a company.
The word “stock” refers to a share of ownership in a particular company. So what does it mean to own stock in a company? If you own a stock, you are an owner of a very small fraction of that company. Let’s take Exxon, for example. Exxon has 4.27 billion shares of stock outstanding, meaning that they have divided ownership of their company into 4.27 billion pieces. Owning a single share would mean that you own 0.0000000189% of Exxon. That’s a very tiny fraction, but Exxon is a huge company, so that tiny fraction has some value.
How much value does that one share have?
Right now, that one share of Exxon stock is worth $68.50 (as of this writing). Shares are traded on an open market, meaning buyers and sellers can both make offers. Sales only occur when buyer and seller agree on a price, so that $68.50 is the amount that someone agreed to sell a share of Exxon stock for and someone else agreed to buy it for. In other words, that’s the value that the public estimates a single share of Exxon stock to be worth.
Currently, Exxon‘s stock is worth $68.50 per share, and thus with 4.27 billion shares outstanding, that means Exxon has a market capitalization of $292.5 billion. Market capitalization is the estimate of the total value of the company – total number of shares out there multiplied by the per stock value.
Why own stocks?
1. Stocks pay dividends.
A dividend is a piece of the company’s profit that it pays out to each shareholder every three months. Continuing with our example, over the last four financial quarters, Exxon has paid out an average dividend of $0.86 per share. If you held 100 shares of Exxon stock for the last twelve months, that’s $344 in dividends.
2.You own a piece of whatever would be earned if the company decided to close up shop.
Exxon has a book value of $45.23 per share. That means if Exxon decided to sell out, the shareholders would get paid out at that price for their shares. It wouldn’t recoup the value of the stock purchase, but it’s something.
3. Larger shareholders can gain some voting rights when it comes to making decisions about the company.
In our example, an individual shareholder owns such a small portion of the company that if they allowed each such holder to have voting rights, nothing would get done with the company. Thus, there’s usually some threshold that people have to cross before they have voting rights and get to participate in corporate decision making. With some companies, that comes in the form of special voting shares where ownership of only those shares allow you to actually vote. In other companies, if you own a small amount, you vote by proxy, meaning you assign someone else to vote on your behalf.
What does the total value add up to?
The stock market is a free-for-all of trading where buyers and sellers can quote whatever prices they want. The “value” of a stock is whatever the buyer and seller agree on as a fair price, and the value is a recently agreed-upon value between an individual buyer and an individual seller. Other buyers and sellers then use this as an indicator when deciding the value of the next trade. If a company has good news, then their stock value may go up. If something bad happens, it might go down. If conditions are neutral, the price will fluctuate a bit but stay fairly static.
The chaos you see on the floor of stock exchanges is basically the chaos of tons of these trades happening at once, with people running around trying to make it happen. Much of the activity happens electronically too.
Ideally, you hope to re-sell stocks at a higher value than when you bought it. That decision point – when to sell – is the topic of countless investment books.
How to buy stock
Many individual stock buyers and sellers go through a stockbroker–which you can do in-person or online. Online stock A stock brokerage is an organization that actually participates in those exchanges. An individual, like yourself, goes to a stockbroker and pays them a fee to use their resources to get that stock for you. They might own it themselves and be willing to sell it to you, or they might have to go buy it from someone else. Either way, your fee pays for this service.
So what’s a mutual fund?
A mutual fund is just a collection of stocks. A typical mutual fund has their stocks chosen by a fund manager and the fees with that fund go to pay the fund manager’s salary (and the salaries of anyone working for the manager). An index fund is a mutual fund without an active manager – it operates based on a clearly-specified set of rules that do not require active intervention. The fees for an index fund are much lower. Some people prefer having an actual person manage the fund; as for me, I’ll take the index fund almost every time.
I wish you luck in your investing. Once you have this basic info in hand, there’s an almost infinite amount of material to learn about the stock market.