What Exactly Is A Stock? | Easy Explanation

You are thinking about investing, you keep hearing about Tesla, or you don’t want to miss out on an opportunity to build wealth.

However, you’re asking yourself, What exactly is a stock?

You might have learned about stocks in high school or college but then totally forgot.

I remember my economics teacher always had the news on during class and I’d always wonder what those symbols at the bottom of the screen really meant.

Do you know what I’m talking about? The symbols that go by so fast you don’t have time to read them?!

What Is a Stock?

The following is the Merriam-Webster definition of a stock.

Stock definition

How’s that for a definition? Makes no sense right? 

Let me explain in terms most people will understand!

A stock is a type of investment. 

A stock represents an ownership position in a company. You might ask, “What’s an ownership position?”

First, it does not mean you own the entire company. It means you own a small (most likely very small) share of the company’s profits. You own a small share because out of the millions of shares, you most likely own a handful or just one. 

To clarify, buying a stock doesn’t mean you own a share of the total company (including its buildings, store, products, etc.). It means you own a share of the company’s profits. 

Make sense? 

Fun Fact: The first stock ever issued (sold to the public) was in 1602 by the Dutch East India Company. That was over 400 years ago!

Stocks vs. Shares vs. Equities

You will hear stocks, shares, and equities used interchangeably. First, stocks and equities mean the same things. In the news, I hear the term equities used more frequently. Just know that equities and stocks mean the same thing. 

What about stocks and shares? There is a difference. 

If you buy one Netflix stock, you own one stock. If you buy five, you own five shares of Netflix.

If you buy one Netflix stock and one Target stock, you own two stocks. In this scenario, you would not say two shares. You use the word share when you are referring to one company. 

If you are still a little confused, don’t worry, nobody is going to grade you or correct you if you use the wrong term. 

How Do Stocks Work?

Your next question might be, how does a stock work?

On a high level, meaning broadly speaking, the way a stock works is simple. The price of a stock goes up and down. To profit from our stock purchase, we want the price to go up.

What makes the price go up or down?

Here are a few reasons that cause the price of a stock to go up or down:

  • Company’s performance. Did the company make a profit or did they lose money?
  • Competition. Is another company doing better and taking their business?
  • Economy. Are people making more money? Is the unemployment rate up/down?
  • Market. Is the price of materials needed to make its products going up/down?
  • Politics. Is there any turmoil between the two countries?
  • Public opinion. Do investors/people believe the company will do well?

The reasons above are in no particular order. However, I list a company’s performance first because in the long run (over 10 years) the price will be determined by the company’s performance.

If the price went up in the last ten years, the company did well. If the price went down, the company did not do well.

How Do You Make Money From Stocks?

There are two ways you can make money from stocks. One, dividends. Two, selling your stock for a profit.

Dividends

If a company makes a profit and decides to share that profit (because they don’t have to) with its shareholders (stock owners), the money you receive is called a dividend.

Overall, dividend payments are small unless you own thousands of shares. And as I mentioned, a company is not required to issue (pay) dividends.

I’ll use Netflix as an example again. The company first issued (sold) stock in 2002. As of 2021, nineteen years later, it has never paid its investors a dividend.

Again, just because you own stock, that does not mean you will get paid a dividend.

Why would a company not pay a dividend? There are a few reasons; One, they choose to invest their profits in the company by buying more buildings, resources, advertising, etc.

Not getting paid a dividend does not mean the company is not doing well or making a profit. On the other hand, it could also mean that they are not doing well.

Unfortunately, the answers are not black and white.

Many factors influence why a company decides to pay or not pay a dividend.

If you intend to invest in stock to get dividend payments, focus on the companies that have historically paid dividends throughout the years.

Sell For Profit

If you sell your stock for a higher price than you bought it, you make a profit.

For example, you bought a stock for $100. You sell it for $120, your profit would be $20.

Also, the profit you make when you sell stocks is taxed. So that $20 profit example above is not all yours.

That $20 will be taxed. It’s also possible to lose money if you decide to sell when the price is lower than you bought it for.

For example, you bought a stock for $50. You sell it for $35, your loss would be $15.

Types of Stocks

There are two main types of stocks.

The main types of stocks are common stocks and preferred stocks.

Preferred Stock

Not many companies issue preferred stock.

The main difference between common stock and preferred stock is that preferred stock owners do not have the right to vote.You would think the “preferred” means you would have voting rights but you don’t.

What preference do you have as a preferred stock owner? You are first in line to get a dividend. It’s possible that after paying preferred stock owners their dividends, there might not be any money left for common stock owners.

Common Stock

Most companies issue (sell to the public) common stock.

When you own common stock, you have the right to vote and dividends.

Remember that not all companies issue dividends. It’s only if they make a profit and decide to share that profit.

How To Buy Stocks

When you’re ready to buy stocks, you’ll have a lot of options.

You can either buy stocks on your own or through a broker. Just know that a broker will charge you a commission.

If you plan on buying stocks on your own. Many places offer commission-free trading (buying and selling) so make sure you do your homework.

The process itself of buying stock is very simple and easy.

For the most part, you’ll first create an account and add money to it.

When you’re ready to buy your stock, you’ll search for the company you want to buy stock from, select the quantity, and buy your stock!

It’s very simple and straightforward.

What’s not so simple and straightforward is choosing which stocks to buy.

For the most part, you and I don’t have the time (or want to) to learn how to read financial statements. Understanding which stocks to buy is a full-time job. A full-time job for financial analysts and educated investors.

So what do we do? The advice for individual investors (you and I) is to invest in index funds. This advice is from the best investors in the world like Warren Buffett and Ray Dalio.

Read Index Funds For Beginners to get a better understanding.

If you want to buy stock from a few different companies and invest in index funds, I don’t think that’s a bad idea but definitely talk to an advisor to make sure you’re correctly balancing your stock portfolio.

What Is a Stock Summary

What exactly is a stock?

A stock is a type of investment.

A stock represents an ownership position in a company. You don’t own the entire company (of course) rather you own a small share of its profits.

How a stock works is simple.

The price goes up and down. If the price goes up, great. If the price goes down, not so great.

Keep in mind that the price of a stock goes up and down daily and that’s normal.

However, over a long period of time (+10 years), you want the price to increase.

When you’re ready to buy stock, do your research.

You and I are not financial analysts. I don’t recommend choosing a handful of shares and putting all your money into them. Meet with the professionals and get their advice first.

Look for an established Registered Investment Advisor (RIA). It will be the best decision you will ever make.

Successful investors, including Warren Buffett, had to wait years and years to make a significant profit from their investment in the stock market. That said, it takes time so be patient.

If you are serious about investing but feel like you need to learn how to manage your finances first, I recommend reading, How Many Bank Accounts Should I Have?

This post will help you understand how to organize your cash flow and maximize your income and savings.

5 thoughts on “What Exactly Is A Stock? | Easy Explanation”

  1. Thank you very much for your nice explanation about stocks.
    But actually, as an investor, you don’t invest in stocks, you invest in companies. You are right that stocks just work, but investing in a company is not that easy. You have to understand the company before you can invest in it. Many people buy stocks on gut instinct without taking a closer look at the company. This is one of the reasons why investors lose money in the financial markets.

    Thanks again for your article.

    Best regards
    Mato

    Reply

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