What Are Stocks?Have you been at the receiving end of the question "what are stocks?" Perhaps you've fumbled around with a description, launching into related topics like stock symbols, stock prices, stock quotes, etc. You have a pretty good notion of what it all means, but let's lay it out in writing so we're all on the same page. Before we answer that question let's consider a hypothetical example. Imagine that you and a few close friends with the entrepreneurial itch decide to start a company. Your company will manufacture this absolutely desirable, "gotta-have", smart widget that you're convinced your customers will never get enough of. After all, people have got to be tired of the regular, run of the mill, "non-smart" widgets. So the team comes up with strong designs that you make into nifty proto-types. Through some smart advertising, you already have a small list of people (mostly family and friends of course) who've decided to buy your widgets. You just can't wait to start making them. One small problem though .....
Making this widget requires investment in facilities and equipment to start with. Fortunately, one of your friends had taken some Finance Classes in College and brilliantly suggests raising money by giving stake in the company to anyone willing to invest. In other words, you will be giving investors stock in your company.
That's essentially what a stock is -- a piece or a share of your business. Your business now becomes a Publicly Traded Company. Each person who owns stock in your company becomes a stock holder (also called share holder). The money you raise from selling stock can now be used to invest in facilities, equipment, advertising, wages, etc. to get your business started and earning cash. A quick note on some terminology here .... the words stock and share. Usually, these words are used inter-changeabily. But, if it helps straighten things for you, you can use stock as a collective term. For instance, you could say, "I now own stock in General Electric -- I bought 50 shares yesterday.
The stock you've issued to the public is traded on a Stock Exchange. The stock price depends, among other things, on the potential earnings of your company. If investors perceive good profitability, you will have more people wanting to get a piece of that pie. That, in turn, drives up the price since it creates more demand than supply. Of course, the opposite is true, too.
Stocks are given a name, a label, when they're traded on the Stock Exchange. This is called the stock symbol. It usually is 2 to 5 letters, depending on the Exchange, that represent the name of the company -- e.g. PG = Proctor & Gamble, AAPL = Apple Inc.
You may also hear the phrase stock quote thrown around. All this denotes is the current price a particular stock is trading for. Free stock quotes can easily be obtained from key Financial Websites like Google Finance, Yahoo Finance and MSN Money. Click here to use Google Finance to look up a free Stock Quote. Our discussion on "what are stocks?" won't be complete until we address one important term ..... dividends. Companies may sometimes decide to make a payout to their stock holders out of a portion of their net income. This can be thought of as a return on stock holder's investment. This payout is called a dividend. This brings us to something called a stock's dividend yield.... a company's annual dividend divided by its current stock price. A stock selling for $50 a share with an annual dividend of $1 a share yields the investor 2%. A company's board of directors determines if dividends are declared or suspended. Not all companies pay dividends. So, in summary, we now have enough understanding to answer the question "What are stocks?". We also know what a stock symbol is, how stock prices are determined, how to look up free stock quotes, and what dividends mean. The foundation has been laid!
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