What exactly is a stock?

So I know this may be on the top of many of your minds. You know investing is a good and right thing to do, but what exactly is a stock?

I'm glad you asked – let's dig in and find out! If you hunt online, some of the definitions for "stock" are difficult to understand. I will explain what a stock is by using a hypothetical example.

Getting Started – What Exactly Is a Stock?
Let's say you are living in the mid 1800's and you are interested in starting up your own buggy whip manufacturing business. There are four basic options available to you to get your company the funding it needs:

-Have a rich uncle.
-Use your own money to startup operations.
-Take out a loan from the bank or other creditors.
-Find partners that are willing to invest in your business venture by selling them a stake in your business.

If you come from a wealthy family, then choice #1 or #2 may be a viable option for you to get your enterprise off the ground. In this hypothetical case, you are not rich – sorry! Now, let's move onto option #3 and explore this possibility. You could take out a loan from the bank if you are able to persuade the bankers that you are not a credit risk. Bad news again – in this hypothetical case, you cannot find a bank that is willing to take the risk and lend you the money – dangnabbit! It seems that the only option that will work for your potential buggy whip company is option is #4.

Selling a Stake in the Business?
So, option #4 it is! Now let's say you decide to take your yet uncreated company and split it up into 1,000 small little pieces. We call these 1,000 pieces shares of stock (equity). If you are able to persuade your friends, family, and other investors to buy a share of stock, they will now own a small piece of your new company. We call these owners of some of the equity in your new company "stockholders" or "shareholders." These stockholders are small owners of the company.

Why would anyone want to purchase equity shares of stock in your company?

Well, let's suppose that your buggy whip manufacturing company is wildly successful. Congratulations – I always knew you were destined for success! The buggy whip manufacturing firm can take three actions with its profits:

Sell off all or part of the company (assets) and return the money to the owners (stockholders/shareholders)
Reinvest the money to expand business and increase revenues (purchase assets)
Pay out the profits to owners (stockholders) and continue operations.

Of course, every company can undertake any number of combinations of these three actions. In this case, because things are going so well, the business will plan to reinvest half of the profits to expand operations. The buggy whip business will take the other half of the profits and distribute them out to stock shareholders (owners).

Stocks and Dividends
This payment to shareholders is known as a dividend. Out of the total pot of money allocated for a dividend, each shareholder will receive a dividend payment in proportion to the amount of stock they own out of the total amount of stock issued. In this case, after reinvestment in the company, let us assume that there were profits of $500,000 that will be paid out as a dividend to shareholders. Because there were 1,000 shares of company stock issued and sold to investors, each investor will receive $500 per stock share that they purchased.

Trading On The Floor Of The NYSE As U.S. Stocks Trim Slide While Consumer Shares Rise On Deal Activity

Why Do Investors Purchase Shares of Stock in the First Place?
All investors purchase a company's stock with the expectations that eventually they will be compensated. These investors are taking a risk by purchasing company shares in the hope that the company will eventually generate a profit. If profits are continually generated, eventually there will be a dividend once the company grows to its desired size or the company will buy-back shares and reduce the total amount of stock in circulation thereby increasing the value of each stock remaining investors hold.

All long-term investors are ultimately after a dividend. Long-term investors base the amount of money they are willing to pay for a stock on an estimate of how much money the company will eventually earn and pay out as a dividend. I will cover concepts behind this method of stock valuation in greater detail in a future post.

Stocks and Risk – All Your Eggs in 3 Baskets?
In the example above, I discussed the stock of a single company – the buggy whip manufacturing company. You can see that if investors are working to limit their investment risk, they understand the wisdom of investing in 25 or 30 companies. If investors had most of their money in just two or three companies, any one company could go bust causing them to lose a substantial portion of their investment.

What Exactly Is a Stock? – Final Thoughts
Historically, investors motivated to purchase stock in many companies (25-30 or more) had to pay large fees known as trading commission. Brokers loved this, but as far as the investors were concerned – not so much... If only there were "stocks" that combined the stock of several companies into a single investment. If such a thing existed, then this "bucket" of stocks would certainly make things easier for us. There would be no need to purchase and track 25 or 30 separate stocks concurrently... We are speaking, or course, of a market index fund.

The post What is a stock first appeared on Money Ahoy.

RELATED: How to improve your finances

How to improve your finances using social media
See Gallery
How to improve your finances using social media
"Friend" Your Credit Cards and Bank

Add your credit card issuers and bank to your social media accounts by "friending" or following them. Large institutions usually offer deals to followers, so you can enjoy a lower APR, higher savings interest rate, or other money-saving promos. In fact, according to U.S. News, social media is often the first outlet that banks choose to share news about upcoming deals.

Social media is also possibly the best way to get in touch with customer service quickly, as it will allow you to get their attention more easily. Just make sure to keep your account information, address, and any other private information off the message boards and social media pages.

Photo credit: Getty

Enjoy Travel and Shopping Deals

There are endless travel and shopping deals available through social media. Retailers often choose social media as the first outlet to announce upcoming sales, so their friends and followers are able to take advantage of the biggest discounts first. Followers are frequently offered early deals, as well.

You can find Twitter-specific deals that can save you on everything from rental cars and vacations to eating out and even buying gifts. Before going out to make any purchases, check Facebook, Twitter, Instagram, and Pinterest to make sure there aren't any deals that you're missing. You can even check social media hashtags, such as #deal, to find the best deals in your area.

Photo credit: Getty

Share Goals

Many financial experts recommend sharing your financial goals online. By setting your goals early and sharing them with the people you love, it can help you articulate what you really want and hold you accountable to achieve your goals. In fact, research has shown that making public statements about goals can help you achieve them more efficiently. However, you never want to reveal anything too personal, such as private information that fraudsters can use against you.

Photo credit: Getty

Get Money-Saving Tips

By following your favorite finance site on social media, you can find endless free money-saving tips and updates. You can also find forums and group discussions with unique money-saving ideas and encouragement from others. You can even find good financial and investment advice online.

Seeing these tips on a daily basis on your social media pages can also be a good reminder each and every day to protect your hard-earned income. After all, we all need a reminder once in a while that we don't really need that new top or expensive latte in the morning.

Photo credit: Getty

Find a New Job

LinkedIn can be an invaluable tool when you're searching for a new job. You can apply for jobs directly through LinkedIn, perfect your resume, and even reach out to potential employers and former colleagues. Contacting them through Facebook or Twitter won't be as effective or as professional as contacting them through LinkedIn.

With LinkedIn, once you have created a professional profile, employers and recruiters can even reach out to you with potential job offers. You can also join LinkedIn groups within your field so you are the first to know about potential opportunities. You can even add examples of your work, recommendations from current or previous coworkers, and any honors you've received to better build your online portfolio.

Photo credit: Getty

Make Connections

Networking through social media can result in better face-to-face communication, potential job offers, and endless contacts in your field. Simply following someone or sharing their social media posts can be a great first step in networking and making connections.

Photo credit: Getty

Build Your Brand

Whether you're promoting your personal business or services, or just want to build your reputation as the best in your field, posting on social media can be a great start. Just make sure to stay consistent so that you can reach as many followers as possible.

Photo credit: Getty

Research More Efficiently

Gone are the days of asking for financial suggestions from friends and coworkers. Whether you're looking for a new financial planner or would like information on which investments to make, you can find more information quickly through social media. With a simple social media search, you can find detailed research on the investment product or financial adviser you're interested in.

You can also find suggestions for dentists and other service providers in your area through social media. This will ensure you get what you're looking for and don't waste money.

Photo credit: Getty

Sell Your Items

If you create and sell items privately, such as through Etsy, social media can be a great free platform for you to advertise your products or services. This can help you bring in more revenue, reach new customers, and show off your work to a limitless audience.

Photo credit: Getty

Make Some Extra Income

There are even ways to make some extra income using social media. If you have a large following, you can publish sponsored tweets or sign up for affiliate accounts, where you will receive your own unique link to earn some extra income when followers make purchases using that link. (See also: 6 Ways to Make Extra Money Using Social Media)

Photo credit: Getty


Read Full Story
  • DJI26935.07-159.72-0.59%
  • NIKKEI 22522079.0934.640.16%
    Hang Seng26435.67-33.28-0.13%
  • USD (PER EUR)1.100.00000.00%
    USD (PER CHF)1.010.00000.00%
    JPY (PER USD)107.520.00000.00%
    GBP (PER USD)1.250.00000.00%