Friday, September 13, 2019

Stock Basics


A stock is a fractional piece of a company that can be bought making that person a part-owner – albeit small – of said company. Typically, the stock is issued when a corporation is attempting to raise money to fund their business, new ventures, or when a corporation goes public on a stock exchange. Commonly, English phrasing implies “stock” is synonymous with “shares”, though there are small nuances. Click below to read on!


For example, ABC Company can issue 10 shares to the public. Mr. Client buys 1 share, and now owns stock in ABC Company and becomes a shareholder. This stock represents a fractional piece of ABC Company. If this company is worth $100 and they issue 10 shares, the stock is priced at $10 each. These stocks can be bought and sold between other people in the stock market where the price fluctuates based on supply and demand. The most notable form of stock issuance comes when a company is transitioning from a private company to a public company. To go public means to issue thousands and thousands of small pieces of their company for sale on the stock market and allow the buyers – the general public – ownership rights. The company is being broken into thousands of tiny pieces to be owned by the public. The company owners will retain a majority of the shares to retain full ownership, but the rest is sold to investors.

Definition of stock: A fractional part of a company that when bought, represents small ownership in the company.

What impact does my ownership interest have? Apple as a company is worth $820 billion [$820,000,000,000.00]. If Suzie buys 1 share of Apple stock – becoming a shareholder – she owns part of Apple. $208 out of the $820 million. With ownership, Suzie can vote on replacing board members and any other events that come to vote. In most cases, the people who started the company or are currently in charge hold a majority of shares and thus hold most voting rights. Generally, one share accounts for 1 vote. So, 100,000 shares account for 100,000 votes (though sometimes 100,000 shares just count as one vote, it’s less common). Shareholders also have the right to the profits and revenues the company earns paid as dividends. Additionally, are subject to any stock appreciation or depreciation.

What’s a dividend? From the example above, Suzie owns 1 share of Apple. Apple has been very successful over the last decade and has been paying a dividend since 2012. A dividend represents a distribution of excess profits from the company to its shareholders. The company will want to use profits to reinvest into the business for growth purposes, potentially compensate exceptional employees on their work, or pay down any debt they have. Anything that’s leftover can then be distributed to the shareholders. For example, Apple’s stock is worth $208 and they stated they would pay a 1.47% dividend. That means they will give each shareholder 1.47% of the $208 stock price - $3.08. Suzie owns 1 share in her brokerage account. Once the dividend is paid, she’ll still see the 1 share of Apple, plus $3.08 in cash from the distribution.

From that point, Ms. Client can elect to leave this as cash or choose to have it automatically re-invested. The automatic re-investment means you get paid the $3.08 in cash, then immediately the cash will buy an equal amount of stock in a fractional amount. Dividends are a taxable event but can be a good way to earn some passive income. It allows the investor to share in company profits and usually means the company has a strong enough balance sheet to be able to compensate shareholders for the risk of owning the stock. Unfortunately, receiving dividends often gets misconstrued. The effect it has on a portfolio balance is misunderstood.

For sake of easier math, here is a hypothetical situation assuming the dividend is only paid to cash. If XYZ Company has stock worth $100 and declares a dividend of $2, what happens? Tony owns 1 share. The day before the dividend gets paid, his account balance shows $100; 1 share worth $100. On the day of the dividend payout, there will be a deposit of $2 in cash to the account AND the share price of XYZ Company will drop by $2. Then, the stock price is $98 and Tony has $2 cash in his account. Thus the total balance still shows $100. A bit confusing for starters.

XYZ Company BEFORE Dividend
  • 1,000 shares outstanding
  • $100 per share
  • Total company value is $100,000 (1,000 shares * $100/share)
  • Issue a $2 dividend for each share

Dividends are distributed from company profits, which are part of the total company value. Dividends do not create additional value for a company. XYZ Company needs to reflect its lost value in the share price. When $2 is paid to each share, XYZ Company loses $2,000 from total value - $98,000. The number of shares remains the same, there were none created or destroyed – 1,000.

XYZ Company AFTER
  • 1,000 shares outstanding
  • $98 per share ($100 -$2)
  • Total company value is $98,000 (1,000 shares * $98/share)
  • Each shareholder now has $2 cash in their account


Here’s what Tony’s account looks like assuming the dividends are NOT reinvested
  • 1 share worth $100
    • Account Value - $100
  • $2 dividend is paid
    • Share price drops to $98
    • The cash balance in the account is $2
    • Account Value - $100


Here’s what Tony’s account looks like assuming the dividends ARE reinvested
  • 1 share worth $100
    • Account Value - $100
  • $2 dividend is paid
    • Share price drops to $98
    • $2 of XYZ Company stock is purchased, about 0.02 of 1 share (still worth $2)
    • Account Value - $100

The result is the same. Whether it’s kept in cash or reinvested, the amount of money in the account (not accounting for market fluctuation) is the same. When a dividend is received, the share price goes down by the dividend amount. It’s a little confusing at first, but the more you start to understand the make-up of companies and the stock market, it will start making better sense.


Coming up next, bonds! 

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