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A Stock is not a Piece of Paper
Course Section 2 - Lesson 1
There once was a money tree. Every day dollar bills would fall from the canopy to the ground where the tree owner, Mr. Jingles, would collect them. Some days just a few bills would fall; other days, hundreds would. While income was inconsistent, it did provide a good life for Mr. Jingles and his family.
One morning, while drinking his coffee, Mr. Jingles was struck with an idea. What if, instead of collecting the money from a single tree, he planted more money trees? He was sure the idea was a good one. The only problem was that more trees would require more land, which Mr. Jingles didn't have. He would have to buy land, but his current money tree provided just enough money for him and his family to live comfortably, and he didn't have enough savings to make the purchase himself.
To raise the money for the land, Mr. Jingles decided to sell an interest in the cash dropped by all of the money trees for the rest of time. This interest is what we refer to as stock.
Stock = a Proportionate Interest in a Company
I've said it before in this course, but stock in a company is simply an interest in a business. Every shareholder owns some amount of the "Equity" of the company. The number of shares of stock that an individual owns is their interest in the business. If a company has issued 100 shares of stock and you own 5 of those shares, you own 5% of the company.
Why Do Companies Issue Stock?
Usually, companies will issue shares of stock for the same reason as Mr. Jingles. They have projects that they believe will be profitable and don't have enough cash to pursue those projects. Selling shares in the company today provides a company with the money they need to initiate a project immediately.
A second justification for issuing stock is the company's current owners' desire to "take the company public" so that they can convert their existing equity holdings into cash. This process is referred to as an IPO or initial public offering.
IPO's give early investors, usually private equity and venture capital companies, an opportunity to sell shares that they've acquired before the company was a publicly traded stock.
What are the Benefits of Being a Shareholder?
Shares holders don't just get to see their holdings on their monthly brokerage statements. Stock ownership provides shareholders with certain rights as a result of their investment. Let's take a look at the six rights of shareholders.
Shareholders have the right to vote on major issues that affect the company. Standard issues that are put to a shareholder vote include the election of a board of directors, potential mergers or acquisitions of companies, and approving dividends paid to shareholders.
Right to Dividends
Investors have a right to any amounts that the company pays to shareholders in the form of dividends. Dividends are paid on a per-share basis. Every shareholder will receive a payment equivalent to their ownership interest times the total amount of dividends payable to all shareholders.
Ownership in the Company
Every shareholder has a claim on the assets of the company. If the company were to liquidate its assets, shareholders are entitled to whatever is left after all debt holders have been paid.
Right to Sell Shares
Every shareholder has the right to be able to sell their shares as they see fit. When an investor purchases shares, they are not committed to holding shares for any amount of time. The investor can sell them as soon as a better opportunity comes along, or they no longer find the shares attractive.
Right to Inspect the Books
Every shareholder has a legal right to inspect the company's books. All company financial statements and filings must be accessible to shareholders, regardless of the number of shares an investor owns.
The Right to Sue for Wrongful Acts
Suppose investors discover that the board of directors has acted in its self-interest at the expense of shareholders. In that case, investors have the right to sue the company for damages.
All of these rights are an important part of being a shareholder. While we typically elevate that status of investor's right to dividends, in reality, if investors were to lose any of their other rights, their ability to earn an acceptable level of return from their investment would be compromised.
Limited Liability of Stockholders
One of the most important features of a stock investment is the fact that investors' liability is limited to their investment in the company's stock. If an investor purchases $1,000 worth of Apple stock, then the worst outcome for the investor is that the price of Apple stock may fall to zero. If the management of Apple commits fraud, while investors would not be happy, they would not have to worry that they may lose their home over the lawsuits that Apple as a company will face.
By the same token, investors can benefit from unlimited upside potential. As long as Apple keeps growing and the value of Apple's shares keeps increasing, the value that is generated accrues to shareholders. There is no limit to how much of an increase in value shareholders may earn.
So that is a Stock
A share of stock is much more than a piece of paper or a line item on a brokerage statement. A share of stock truly represents an interest in a company with all of the rights that an investor in a company should expect.