Key takeaways
- A stock, also called an equity, is a share of ownership in a company; the words stock and share are used almost interchangeably.
- Shareholders can benefit from a rising share price and from dividends, but neither is promised, and the price can fall.
- Common stock usually carries votes; preferred stock usually does not, but its holders are paid dividends first and rank ahead of common holders in a liquidation.
- If a company is liquidated, bondholders are paid first, then preferred holders, and common stockholders get whatever is left, which may be nothing.
- Public companies file regular reports with the SEC, which anyone can read on the EDGAR system.
A stock is a share of ownership in a company. Investor.gov, the SEC's site for individual investors, defines stocks as a type of security that gives stockholders a share of ownership in a company, and notes that stocks are also called equities. Buy one share of a company with a million shares outstanding and you own one millionth of it.
That sounds simple, but "owning a piece of a company" has specific meanings: certain rights, certain ways to gain, and a definite place in the queue if things go wrong.
What ownership gives you
Owning common stock usually brings three things.
- A claim on the company's value. If the business grows and investors value it more highly, the share price can rise. This gain, called capital appreciation, is realised only when you sell.
- A possible share of profits. Some companies pay part of their profits to shareholders as dividends. Others do not; Investor.gov notes growth stocks rarely pay them. The dividends guide explains how payments are declared and who receives them.
- A vote. Investor.gov notes that common stock entitles owners to vote at shareholder meetings.
What ownership does not give you is a say in daily decisions, a right to the company's cash, or any promise that the shares will be worth what you paid.
Common and preferred stock
| Common stock | Preferred stock | |
|---|---|---|
| Voting rights | Usually yes | Usually no |
| Dividends | Paid after preferred holders, if at all | Paid before common holders |
| In a liquidation | Last in line | Ahead of common holders |
Investor.gov summarises preferred stock in these terms: usually no voting rights, but dividends paid before common stockholders and priority over common stockholders if the company goes bankrupt and its assets are liquidated.
Why companies issue stock
Selling shares lets a company raise money without borrowing it. The buyers become part-owners and share in the risk and any reward. A company first sells shares to the public in an initial public offering; after that, the shares trade between investors on the stock market, and the company receives nothing from those later trades. How the stock market works explains that second step.
How shareholders can lose
Investor.gov is plain about the risks. Stock prices move down as well as up, and there is no guarantee that a company will grow or do well, so investors can lose money. Prices can be moved by events inside the company, such as a faulty product, or outside it, such as political or market events. Investor.gov also notes that large-company stocks as a group have lost money in about one year out of three, on average.
The worst case is bankruptcy. If a company's assets are liquidated, the order of payment is:
- Creditors, including bondholders.
- Preferred stockholders.
- Common stockholders, who get whatever is left, which may be nothing.
That ordering is why stocks and bonds carry different risks; stocks versus bonds compares them directly.
Ways people describe stocks
Investor.gov sorts stocks into rough categories:
- Growth stocks, with earnings growing faster than the market average; they rarely pay dividends.
- Income stocks, which pay dividends consistently.
- Value stocks, with a low price-to-earnings ratio, which may reflect that they have fallen out of favour.
- Blue-chip stocks, shares in large, well-known companies with long histories.
Stocks are also grouped by company size, measured by market capitalisation: large-cap, mid-cap and small-cap. Investor.gov warns that very small "microcap" and "penny" stocks may have little or no earnings and are highly speculative.
These labels describe characteristics, not quality. A stock in any category can rise or fall.
Where the information comes from
Public companies register their stock with the SEC and, in most cases, file reports quarterly and annually; the annual reports include financial statements audited by an independent firm. Anyone can read them free on the SEC's EDGAR system. The SEC's Beginners' Guide to Financial Statements explains how to read the balance sheet, income statement and cash flow statement they contain, and FINRA's guide to evaluating stocks covers the ratios analysts commonly derive from them.
Learning the mechanics without risk
Vocabulary becomes concrete when you watch it work. Learn to Trade Stocks Beginner starts its lessons with exactly this point, that a stock represents ownership in a company, and then lets you buy and sell shares with a virtual balance, so you can see positions and profit and loss move without real money involved. It is one of our education apps, and the investing basics hub lists the guides in a sensible order.
Good to know
Frequently asked questions
What is a stock in simple terms?
Is a stock the same as a share?
What is the difference between common and preferred stock?
Can a stock become worthless?
Sources
- Stocks – FAQs (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
- Evaluating Stocks (opens in a new tab)FINRA — accessed
- Beginners' Guide to Financial Statements (opens in a new tab)U.S. Securities and Exchange Commission — accessed
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