A “stock” is ownership in a corporation, whether it is one of the world’s largest publicly-traded companies (like Apple, Exxon and Wal-Mart) or the corner “Mom and Pop” grocery store. When a company is established as a corporation, it becomes a separate legal entity under the laws where it is located. A partial ownership in a company is referred to as a “share,” so the ownership amount is often referred to as shares of stock.
When you hear people talk about stocks, they are usually referring to publicly-traded stocks. We have all seen the videos of the men and women yelling, screaming, and throwing up hand signals. No, I’m not talking about college football games! The chaos-filled environments I’m referring to are the stock exchanges, where traders buy and sell stocks and scribble down their orders on sheets of paper. Today, of course, not all buying and selling of stocks and other investments is done this way. Each year, more and more investing is done electronically. When one investor or broker inputs the desired stock into the computer, it is automatically matched with someone who wants to sell. No funny jackets are required (unless that’s just your thing).
Typically, publicly-traded stocks are created when the owners of a company want more money for their business. They might want to use the money to expand their operations, to refinance debt, or to “cash in” on what they’ve built.
Here’s an example from my “Secrets” book: Jim Martin owns Martin Toy Company (a fictitious company); he sells toys from a local store. Jim decides to “franchise” his toy stores all over Florida and takes out a loan from a bank to help pay for the new stores. A couple years go by; Jim decides that he wants to expand his company across the country. He talks to Boldman Slacks, a large investment company who can assist him in turning Martin Toy Company into a publicly-traded stock. For a fee, Boldman will help Jim send the right paperwork to the Securities and Exchange Commission (SEC), which is the government agency charged with overseeing and regulating all publicly-traded companies.
Jim wants to raise $100 million by selling 80% of his company. His plan is to sell 5 million shares at $20 per share. He wants to hold onto the rest, believing that owning 20% of a large, nationwide corporation will be better than 100% of a small, regional toy store.
When it “goes public,” and is listed on one of the major stock exchanges, Martin Toy Company gets its “ticker symbol,” MTC, and starts being sold on the open market to investors. Through this process, Jim’s company will get the $100 million (less fees, of course). This is called an Initial Public Offering (IPO). The price per share of the company will fluctuate based on expected performance. As a publicly-traded company, MTC could potentially end up with thousands of shareholders. If Jim remains president of the company, he will report to these investors about how the Company performs and grows.
When shareholders want to sell their stock, they simply log in to their brokerage accounts or call a broker. It’s an easy transaction for the seller, since most stocks usually have a buyer on the other end wanting to purchase those shares. After the company has had its IPO, the price of the stock is determined by thousands of buyers and sellers in the marketplace. If MTC announced that they tripled sales this year and are reporting record profits, more likely than not, a higher number of investors will want to own the stock. Not unlike an auction, each investor bids a little more than the last to become an owner of the stock – pushing the price of the stock higher and higher. The opposite thing can also happen; if there are more investors who want to sell a stock, they will lower their price in order to find a buyer. Supply and demand have a big impact on how individual stocks are “priced” by the stock market and how the overall stock market performs.
Stocks aren’t as complex as they sometimes seem. Just remember that individual corporations can fail. Don’t go “all in” on one company. Diversify your portfolio with a large number of individual stocks or mutual funds (which are typically comprised of a hundred or more stocks). If one company goes “belly up,” there are many other companies in the mutual fund to help compensate for the loss.
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.