Stocks also known as “shares” or “equity” allow you to buy a certain percentage of ownership of a public company trading on the stock market. The number of shares that you buy would represent a claim on the company’s assets and earnings.
When you purchase shares of a public company, you’re known as a shareholder. As a shareholder, you’re eligible to participate in the company’s profits through pay out of dividends plus you’re eligible for voting rights.
Listing on the Stock Market
Private companies become public companies when they list on the stock exchange. A stock exchange is a marketplace for trading securities, commodities, derivatives and other investment instruments. There are multiple stock exchanges and before a company decides to “go public”, they must meet listing requirements of the exchange that they’re listing on.
Example: NASDAQ and New York Stock Exchange have listing requirements that a company must meet before they get approved. Some of the requirements include: shares outstanding, company value, initial share price, number of shareholders and more!
Initial Public Offering (IPO)
When a private company is looking to go public, they must do an “IPO” also known as an “initial public offering.” During this process, the company will be looking to sell its private stock to the general public.
As a company “goes public”, regular investors are allowed to buy shares of the company that was once private. Public companies face strict rules and regulations. For example, they must have a board of directors, report their financial information every 3 months and must make sure that inside information is not communicated to the general public.
Advantages of “Going Public”
Going public has various positive advantages for a company. Some of the advantages include:
- Raise Cash – By going public, companies are able to raise cash through the sale of shares. Companies can use this cash to expand their operations and aim for growth.
- Public Image – Listing on a major stock exchange has a level of prestige that comes with it. Public companies are more well known than private companies.
- Credibility – Before a company goes public, they must meet various requirements – revenue, shares outstanding, initial share price, balance sheet, etc. These strong requirements provide a public company with greater credibility than a private one.
- Access to Capital – Due to the increased scrutiny, private companies are able to get better financing rates.
- Human Capital – Public companies are allowed to issue shares and encourage employees to participate in stock ownership plans. This helps align the interests of the company with that of the workers.
Shareholders
When you purchase shares of a public company, you’re known as a shareholder. As a shareholder, you have ownership stake in the company and are eligible to receive dividends. In addition, you have the right to vote on certain issues relating to the company and be elected on the board of directors.
There are two types of shareholders, common shareholders and preferred shareholders.
Common Shareholders – Common shareholders hold common shares of a public company. Most shares in the public market are owned by common shareholders who have the right to vote during the company’s annual shareholders meeting. The shareholders meeting allows them to vote on issues pertaining to the company and select the company’s board of directors.
Preferred Shareholders – Preferred shareholders own a company’s preferred stock and have no voting rights. They cannot vote on matters that pertain to the company. However, they’re eligible to receive annual dividends before common shareholders. If the company was going through bankruptcy, preferred shareholders are paid first before common shareholders.
Risk Level of Stocks
The majority of people have stocks in their investment portfolio. Since 1926, stocks have returned an average rate of 10% annually since 1926. This is a higher return that you would normally receive from other investment instruments such as bonds, which are less risky. Stocks are on the far-right end of the risk/reward spectrum. The more stocks that you’re holding in your portfolio, the more volatile your portfolio will be. However, you will experience a higher return long term if you’re buying established, blue chip companies that have a fairly stable stock price, pay out dividends and are considered relatively safe.
Trading Stocks
Millions of stocks are bought and sold each day in the stock market. Shares of public companies may be sold to other shareholders who might be interested in being a shareholder of a particular company. Stock exchanges connect buyers and sellers together through electronic communication networks (ECN) in order to facilitate these transactions.
Buying a Stock – There are several methods on how stocks can be bought. The two most common methods are either through a online brokerage or through a stockbroker. It all depends on your comfort level and knowledge of stocks.
- Online Brokerage – Interested individual can open an investment account at an online discount broker. These discount brokers typically charge less than $10 per stock trade. They do not give investment advice and are not responsible for the performance of your investments. Discount brokers are for individuals who are sophisticated and can do their own fundamental research on a company’s profitability themselves.
- Full Service Brokerage – If you’re not comfortable in doing your own stock purchases, you may utilize a full service brokerage. These full service brokers typically charge a higher commission per trade but also provide you with investment advice and a personal touch. Brokers can be found at banks, wealth management firms, credit unions, etc.
Selling a Stock – Selling a stock is similar to buying. When you sell, you have to be aware of any capital gains that may be triggered. Capital gains are triggered if you’re purchasing your stocks in a non-registered investment account. Selling a stock also involves a commission that gets paid to the broker.