Shares of stock represent a fractional ownership interest of the company that issued them. By owning a share or multiple shares, investors may receive returns through capital appreciation if the stock’s price rises or from dividend payouts. They also gain the ability to influence the company through their votes as a shareholder.
This article will explain what shares are, why companies issue them, and the different types of shares.
Definition and Examples of Shares
A share of stock represents an ownership interest in a company. That ownership interest is proportional to the number of shares that the company has issued. For example, suppose a hypothetical company has issued 50 million shares of stock. Five million of those shares would be 10% and represent 10% of the company.
Companies issue shares to raise capital for things like physical expansion, research and development of new products, or expansion into new markets.
In addition to the potential for capital appreciation and dividends, owning shares grants the holder a right to elect members of the board of directors and vote on some key management decisions, such as mergers and acquisitions or stock splits.
How Shares Work
The number of shares a company may issue is defined in the corporate charter. The maximum amount allowed is known as the authorized shares. A corporation does not always issue all of the authorized shares.
Shares that have been issued and are currently held by stockholders are said to be outstanding. The corporation may even repurchase some of the shares it has previously issued; these are called treasury stock. A corporation is likely to do this if it wants to send a signal to the market that the shares are a good value or to use them as part of employee benefits and compensation plans.
Treasury stock does not receive dividends and does not convey voting rights to the corporation itself.
Types of Shares
Shares come in two basic types: common and preferred. While a shareholder can own either or both, each type of share provides different benefits and rights.
Common shares grant the holder a right to participate in the earnings of the company through the receipt of dividends and to vote.
Preferred shareholders generally do not receive voting rights. The dividend paid to preferred shareholders is normally fixed, unlike the dividend paid to the common shareholders, which may increase if the company’s earnings increase.
Preferred shareholders are also higher in priority to be paid in the event that the company goes bankrupt, although they are still behind bondholders.
Alternatives to Stock Shares
Issuing shares of stock is not the only way that businesses can raise capital. Firms can also acquire capital by borrowing. One way a business can borrow is by issuing bonds that investors can purchase.
Unlike shareholders, bondholders are not owners. Bondholders do not have voting rights and do not participate in the growth of the company. Bondholders typically receive regular interest payments and then a return of the face value of the bond at the maturity date, or the end of the loan term.
Pros and Cons of Owning Shares
Because of the potential for receiving capital appreciation and dividends, owning shares of stock can be a good way to increase your wealth or reach long-term financial goals.
However, there are some risks associated with share ownership.
The share price could increase.
You may receive dividends.
Your liability is limited.
The share may decline in value.
The company may not pay dividends.
- The share price could increase. It is possible that a share rises in price after the investor purchases it. That increase in value is a capital gain that the investor gets to keep if they later sell the share.
- Companies may pay dividends from their earnings. A cash dividend is distributed to shareholders in proportion to the number of shares they own.
- Your liability is limited. This aspect of share ownership means that you can lose only the amount you pay for the shares. Even though you are an owner of the company, creditors cannot hold you personally liable for any additional debts or obligations the business incurs.
- A share’s price could fall after an investor purchases it. When that happens, the investor experiences a loss, which could potentially equal the full value of the stock purchase.
- The company may not pay dividends. Unlike interest payments on a bond, dividends are not contractually guaranteed. If the company does not have adequate earnings, it may decide to cut its dividend.
How to Purchase Shares of Stock
Before you buy shares, make sure that you understand the risks and invest only in stocks that are appropriate for your risk tolerance and goals.
- Shares represent ownership of the company that issued them.
- Investors could earn a return through dividends and increases in the share’s price.
- Corporations issue shares to raise capital for the business.
- Owning shares of stock can provide value and help you reach your financial goals, but there are risks.