What is a Stock?

Want to own part of a business without having to show up at its office every day? Or ever?

Stock is the vehicle of choice for those who do. Dating back to the Dutch mutual stock corporations of the 16th century, the modern stock market exists as a way for entrepreneurs to finance businesses using money collected from investors. In return for ponying up the dough to finance the company, the investor gets shares of stock-specialized financial “securities,” or financial instruments-that are “secured” by a claim on the assets and profits of a company.

Types of Stock:

Common Stock….

Common Stock is aptly named, as it is the most common form of stock an investor will encounter. It is an ideal investment vehicle for individuals because anyone can own it; there are absolutely no restrictions on who can purchase it. Young, old, savvy, reckless, genius and idiot are all invited to participate. Common stock is more than just a piece of paper (today, it’s more often electronic anyhow); it represents a proportional share of ownership in a company—a stake in a real, living, breathing business.

By owning stock—the most amazing wealth-creating vehicle ever conceived (except, maybe, for just inheriting money from a rich relative)—you are a part owner of a business. Shareholders “own” a part of the assets of the company and part of the stream of cash those assets generate. As the company acquires more assets and the stream of cash it generates gets larger, the value of the business increases. This increase in the value of the business is what drives up the value of the stock in that business.

Because they own a part of the business, shareholders get one vote per share of stock to elect the board of directors. The board is a group of individuals who oversee major decisions made by the company. Far from being a perfunctory collection of do-nothings, the board normally wields quite a bit of power in the corporate world.

Boards decide how the money the company makes is spent. Decisions on whether a company will invest in itself, buy other companies, pay a dividend, or repurchase stock are all the purview of the board of directors. Top company management—who the board hires and fires—will give some advice, but in the end the board makes the final decision.

As with most things in life, the potential reward from owning stock in a growing business has some possible pitfalls. Shareholders also get a full share of the risk inherent in operating the business. If things go bad, their shares of stock may decrease in value—or even end up being worthless if the company goes bankrupt.

Different Classes of Stock:

Occasionally, companies find it necessary for various reasons to concentrate the voting power of a company into a specific class of stock where the majority is owned by a certain set of people. For instance, if a family business needs to raise money by selling equity, sometimes they will create a second class of stock that they control that has ten votes per share of stock and sell a class of stock that only has one vote per share to others. Does this sound like a bad deal?

Many investors believe it is and routinely avoid companies where there are multiple classes of voting stock. This kind of structure is most common in media companies and has been around only since 1987.

When there is more than one kind of stock, they are often designated as Class A or Class B shares. On the New York Stock Exchange and the American Stock Exchange this is signified by a period and then a letter following the ticker symbol, a shorthand name for the company’s shares that brokerages use to facilitate transactions.

For instance, Berkshire Hathaway Class A shares (Warren Buffett’s company) trade as BRK.A, whereas Berkshire Class B shares trade as BRK.B. On the Nasdaq stock market, the class of stock becomes a fifth letter in the ticker symbol. For example, TeleCommunications, Inc. has TCOMA, the Class A shares, and TCOMB, the Class B shares. In Singapore, you will often find a “domestic” class and a “foreigner” class of stock, whereby foreigners are limited to a certain percentage ownership in a given company.

This practice has been less prevalent in recent years, and some companies are now even beginning to merge their domestic and foreign classes into a single listing. You may also encounter different classes of shares that trade various minimum lot sizes, such as SPH (1,000 share lot minimum trades), and SPH 100 (100 share lot minimum trades). This is gaining popularity as companies look to make their stock more available to small investors.

Preferred Shares…

Preferred stock is issued by a company as a less risky investment, being closer to a bond than a stock. The preferred shares often pay a higher dividend payment than the common shares. Also, in the case of bankruptcy, company assets are liquidated to first pay bond holders, then preferred share holders, and lastly, common share holders.