Stock is an investment vehicle that represents partial ownership in a company. Companies issue stock when they need to raise money. Stocks can be sold in different exchanges or markets. The most popular are the New York Stock Exchange (NYSE) and the NASDAQ. Stocks are issued in denominations called shares. The price of a share varies according to what company has issued it and how much people want to own a part of that company. Stock has no inherent value, only what someone is willing to pay for it. This is what makes investing in individual stock a risky venture. If a company becomes involved in a scandal or experiences financial distress, its stock price (the amount people pay to buy one share of stock) could plummet rapidly as many people wish to sell but few buyers are available.
There are different types of stock available, each with varying rights and privileges:
- The most prevalent type of stock is called Common Stock. Common stock entitles the owner to voting rights at company stockholder meetings and to dividends (payouts) when dividends are issued.
- Preferred Stock. Preferred stock is specialized stock which entitles stockholders to dividend payouts before common stockholders. If there is only a limited amount of money to fund dividends, preferred stockholders will get that money before common stockholders will. The trade off with preferred stock is that preferred stockholders generally do not have voting rights.
Most people do not gain access to preferred stock. Such stock is often sought by institutional investors and investment bankers who want to be able to recoup as much investment as possible in the event that a business fails. Some preferred shares are Cumulative Preferred Shares, which accrue (store up) dividends until such time as the company is able to pay them.
Other Stock Types and Concepts
- Authorized Stock. This is stock that was authorized when a company was created or when it went public (when it first offered its stock to the market).
- Treasury shares. This is stock that the company retains ownership of and does not trade on the market.
- Restricted Stock. This is stock that the company has reserved for special purposes such as employee incentives and/or compensation. This stock cannot be sold without the permission of the SEC (Securities and Exchange Commission: the government division that regulates the stock exchanges).
- Float Shares. These are stock shares that are available for people like yourself to buy.
In addition to granting and selling stock, companies can also create and grant stock options, which are rights to purchase stock at a particular price. Stock options are usually granted to company executives and employees as a means of rewarding their performance. Stock options typically have covenants that govern how they can be used, whether they can be resold, and when they expire. The value of a stock option is generally less than that of stock itself by the difference between the price of the stock on the market, and the price that the option owner can get the stock for by exercising the option. The option owner can exercise the option by paying the price of the share defined on the option. In exchange he gets a share of stock. If the stock was trading at a higher value than the option allowed him to buy it for, he or she will have an unrealized gain (instant equity) by exercising the option. This gain can be realized be selling the stock and taking the profit as a cash payout.