What Are Stocks

When you buy shares of a company, you purchase part ownership in that company. As a shareholder, you also expect to receive capital appreciation — the difference between your purchase price and the market price of your shares — on your investment. If the company prospers, your shares of stock increase in value. If company performance declines, the market value of your shares also decreases.

Shareholders are the owners of corporations. If you buy just one share in a company, you are a shareholder. As a shareholder, you’re invited to the company’s annual meeting. Additionally, you have the right to vote on the members of the Board of Directors and other company matters.

The dividend a corporation pays is the amount of money, usually a portion of the profits, a board of directors distributes to the ordinary shareholders of the corporation. For example, if a company has one million shares outstanding, and it decides to distribute 3 million dollars to its shareholders, then the dividend per share is $3 (3 million dollars divided by one million shares). Some successful firms, such a Berkshire Hathaway, don’t pay dividends. These companies usually plow dividend payout funds back into the company to finance expansion, which increases the value of the company and the price of shares stockholders own. In other words, if all goes as planned, the stockholders get capital appreciation instead of a dividend check. Some investors in high tax brackets prefer this approach. They don’t have to pay taxes on capital appreciation until they sell the stock. With dividends, investors have to pay the taxes right away.

The annual return is the percentage difference of the stock price at the beginning of the year from the stock price at the end of the year plus any dividends paid. The price at which you can buy or sell a share of common stock can change radically. As a matter of fact, stock prices are so volatile that accurately predicting annual returns is impossible. (If we had this gift, we would all be rich!)

Common stock returns can vary — for example, from a depressing –43.34 percent in 1931 to a thrilling 53.99 percent in 1933. However, over 73 years, investments in the stock market have consistently outperformed any other type of investment. For example, the return on $1 invested in the S & P Index from the year-end of 1925 through 1998 would be $2,350.89. A dollar invested for the same 73 years in Treasury bonds would be worth $43.93. For answers to questions like “What is stock?”, “What are different types of stocks?”, “How do stocks trade?”, and “What causes prices to change?”, see Investopedia at www.investopedia.com/university/stocks.