What is a Share?

A Share is a financial asset that represents equity ownership of a company. A Share is the smallest unit of the capital of a company thus it is the smallest unit of the ownership of that company.

For example, Let’s say company XYZ’s current market capitalization (valuation) is 500 USD. XYZ company currently has 50 outstanding shares.

• 1 share of the company XYZ represents 2% ownership of the company XYZ.

• The price of 1 share of the company XYZ is 10 USD. You derive that by dividing the Market Capitalisation (500 USD) by the current Number of Shares (50)

What is a Stock?

A Stock is also a financial asset that represents equity ownership of a company but not the smallest unit. A stock is a collection of shares. Stock is an unquantifiable unit of ownership in a company. Stock is a more general term and could represent your ownership in many companies as well. Stocks are also called Stock Certificates.

If someone says that he owns stock in the XYZ company, it means that he owns a part of the company XYZ but it doesn’t tell us about the size of his investments. To measure the size of our investment stocks are divided into the smallest units of ownership called shares.

There are no fixed rules about how many shares a stock should have. It depends on the company and/or the stock exchange. 1 stock can be comprised of 1 share, or 10 or 100, or any number.

Why do companies issue their Shares?

A company needs capital to fund its existing operations, expansions of operations, etc. A company can arrange capital by borrowing money, debt financing. Another way for companies to raise capital is by issuing new shares. Issuing new shares/stocks are called equity financing.

Companies prefer to raise capital by issuing new shares when they want to avoid debt financing. Debt financing comes with mandatory interest payment and the borrowed capital needs to be paid back within the stipulated time. For equity finance, companies don’t need to pay back the money or any interest since the shareholders are getting a part of the company.

How do companies issue their Shares?

Issuing shares for a company is very simple, it is achieved by increasing the total number of share count. Each company keeps a registry in which they maintain the number of shares and the owners of the shares.

When a company issues more shares, it dilutes the existing shareholder, meaning the current owners own a little less percentage of the company. Even though dilution is bad for current owners but still it can be justified because, with the raised money, the company can grow, make more profit, and thus the value of each share can increase. A company issues shares.

A private company issues shares to private investors who are often known as angel investors. When a company wants to become public limited, they usually use Investment banks to issue new shares through IPO (Initial Public Offerings).

What are the different types of Stocks?

Generally, stocks are divided into two main types, Common Stocks and Preferred Stocks. Preferred Stocks are divided into a few other categories. We will discuss that later. In addition to Common and Preferred stocks, we have Employee Stock Option (ESOP).

Common stocks

The most common type of stock issued by a company is common stock, hence the name. Common stocks generally have voting rights. If you own a large number of common stocks of a company, you may influence the management decisions and directions. The prices of these stocks fall and rise according to the demand and supply in the stock market. Common stockholders are also entitled to dividends if the company decides to pay a cash dividend. It is not an obligation for the company to pay dividends to the common stock shareholders. The company may choose to stop paying dividends if the business is facing financial trouble or if the company decides to invest in the growth of the business.

Preferred stocks

Preferred Stocks are another type of stock a company issues for equity financing. Preferred stocks usually don’t have any voting rights. Preferred Stocks have guaranteed dividends. The dividend amount is usually fixed. For those reasons Preferred stocks are not as much volatile as common stocks. In case of any liquidation event, the preferred stockholders get the preference over the common stocks in their obligations getting met.

Types Preferred stocks

1. Convertible – Convertible preferred stock gives the stockholder the option to convert his convertible preferred stock to shares of common stock. Investors often buy this type of preffered stock because it allows the investors to benefit from a rise in share price in the common stock.
2. Participating – Through Participating Preferred Stocks Investors not only get regular entitled dividends but can also get extra dividend. The extra dividends are usually bound with some conditions. For example, if companies reach predetermined goals like earning additional profits.
3. Cumulative & Non-Cumulative – Generally, dividends are made at the discretion of the company, so it can be the case that company might not declare a dividend in a financial year. Being a cumulative preference shareholder, you will be entitled to receive that dividend in the next year. But Non-cumulative preference shareholders are not entitled to receive dividends that they have missed out on in the past. 
4. Callable – These are the preferred shares that are issued, where the company can call/buy back the shares at a pre-determined price at a future date. These types of preferred shares are issued by the company to put a cap on its liability.

3. Employee Stock Option

The ESOP is offered to employees where they have the option to redeem their stock in the future. Then there are bonus stocks where more shares are issued to existing stockholders without any cost.

What is a Stock’s Dividend, Dividend payout ratio, and Dividend Yield?

Stock dividend is a cash distribution of profits by a company to its shareholders. When a business earns a profit or surplus, it can decide to pay a proportion of the profit as a dividend to shareholders.

Let’s say a company’s earning per share (EPS) is 3 USD this year and they decided to distribute 1 USD out of the 3 USD profit. So, the annual dividend is 1 USD and the payout ratio is 33%. Divide the paid Dividend by EPS and you will get the Dividend payout ratio.

Let’s say the share price of a company is 25 USD and this year the company paid 1 USD as a dividend. So, the Dividend Yield is 4%. Divide the paid Dividend by Stock Price and you will get the Dividend Yield.

Any amount not distributed is taken to be re-invested in the business.

What is Stock Buyback and Buyback Yield?

The share buyback is another way a business return value to the shareholder. The share buyback is a program through which a company buys its own shares and then destroys those shares. For that reason, current shareholders increase the ownership percentage of the company without spending any more money out of shareholders’ pockets.

For example, let’s say a company has 100 shares outstanding which is representing 100% of the company. You bought 1 share, so your current ownership in the company is 1%. Now, let us assume that the company bought back 50 shares in the next 5 years. Now, after 5 years they have only 50 shares outstanding and you still own your 1 share. This means, now you own 2% of the company.

Buyback is also a more tax-effective way for businesses to return a profit to the shareholders than cash dividends.

What is Stock Dilution and Stock Split?

Stock dilution

Stock dilution is the opposite of stock buyback. When a company issues new shares that dilute current shareholders. Meaning current shareholders will own a little less percentage of the company.

For example, let’s say a company has 100 shares outstanding which is representing 100% of the company. You bought 1 share, so your current ownership in the company is 1%. Now, let us assume that the company bought back 50 shares in the next 5 years. Now, after 5 years they have only 50 shares outstanding and you still own your 1 share. This means, now you own 2% of the company.

Stock Split

A stock split or stock divide increases the number of shares in a company. This increase is not the same as dilution. A stock split does not increase or decrease the ownership percentage of the company. A stock split causes a decrease in the market price of individual shares, not causing a change in the total market capitalization of the company.

For example, let’s say a company has 100 shares outstanding which is representing 100% of the company. You bought 1 share for 50 USD. So your current ownership in the company is 1%. The company did a 5-to-1 stock split. That means, Before the split, one share was 50 USD and after the 5-to-1 Stock split, one share is 10 USD. Before the split, one share was 1% of the company and after the 5-to-1 Stock split, one share is 0.20% of the company and you still own 1% of the company.

How Stock Price or Quote is determined?

The price of the stocks in the stock market is determined based on supply and demand. If the demand is high for any stock it will result in an increased price and vice versa. However, there are certain external factors that affect the demand and supply of the stock. For example, the economy of a country, company financials, industry attractiveness, market trends, positive news, etc. can increase the demand for a stock.

Why should you buy Stocks?

Nowadays, there are a plethora of options to invest and generate risk-free returns. None of the instruments can beat the wealth/return that the stock market has created for its investors in the long run. In the last 5 years, S&P 500 index has given around 115% return. Whereas blue-chip companies like Apple have increased their shareholders’ wealth by 420% in the last five years. Comparing it to other favored investment options like gold which has increased only by 44% in the last 10 years.

How can you make money from Stock?

There are various ways one can make money through the stock market. Followings are three major ways:

1. Share Buybacks- The share buyback is a program through which a company buys its own shares and then destroys those shares. For that reason, current shareholders increase the ownership percentage of the company without spending any more money out of shareholders’ pockets. Companies notify buyback of shares beforehand.
2. Dividends – Dividends are cash that is distributed among all the shareholders from the profits of the company. If you are holding let’s say 100 stock of IBM which pays a regular quarterly dividend of 1.24$, then you will be receiving 124$ each quarter the company declares the dividend. Generally, companies notify when they wish to declare a dividend and set a record date (cut off). If you buy the stocks of that company before the record date, you will receive the dividend as well.
3. Capital Gains – When you sell your stocks, the profit you have earned is called capital gains. It can be Long term capital gains called LTCG or short-term capital gains called STCG. These capital gains are taxable as per your country’s tax laws.