Introduction to Stocks

Introduction

Throughout the world the word stocks and shares have left individuals baffled and many think it is a complicated instrument which is traded on the financial markets and it is somehow the root cause of financial crashes.

Stocks are financial instruments that gives an individual or institution, a share of the ownership of a company that is traded on the stock exchange. An individual or an institution can hold stocks and depending on the number of stocks bought own, part or whole of a company. These instruments are traded on stock exchanges which are markets for buyers and sellers. Stocks can be traded on either the primary or the secondary markets. There are also two main different types of stock, common stock and preferred stock.

What are stocks?

As previously mentioned stocks gives individuals and institutions a share of the ownership of a company but why the company sell ownership to any common folk would. Well, the answer is that companies do this in order to raise capital and money for their business and in giving away a share in the company, investors will give them the money to expand and succeed. The main benefit of owning stocks are that if the company makes a profit the investors will bear fruit in the form of dividends which are returns on their investment.

Primary vs secondary markets

Primary markets are where investors can buy stocks directly from the issuing company rather than an exchange, this is called the IPO(Initial Public Offering). Investment banks usually act as the brokers in this deal. The price is usually set low and because no one knows how the markets will react the price usually goes up and down and so the primary markets are very volatile.

Secondary markets are where investors purchase stocks from other investors rather than the issuing company. These markets are what is known as the stock exchange. The basic factors that determines the price of the stock in the secondary markets are  supply and demand. It is not as volatile as the primary markets.

The most basic way to distinguish the two different markets are to think about cars. The primary market is a bit like the showroom dealers (who play the part of the investment banks) that sells you brand new cars and the secondary markets are people that sell used cars to you.

Exchanges in which stocks are traded

Just like any other products stocks are traded on exchanges which are market places. In the UK we have the London stock exchange which has a main index called the FTSE 100 which are the 100 biggest companies based on market capitalisation, the FTSE 100 has listings of famous companies such as HSBC,DIAGEO(owns Guinness , Johnnie walker and Smirnoff) and IAG(owns British Airways) .

In the U.S there are two main exchanges the NYSE and the NASDAQ. At present NYSE has listings of  companies such as McDonalds, Coca- Cola, Walmart, General electric etc. NASDAQ however is an exchange that is OTC (Over The Counter) and all the stocks are traded electronically through computers. NASDAQ is also an exchange that mainly deals with stocks that belong to companies that are in the technology industry such as Apple, Microsoft and Dell to name a few.

Common stock vs preferred stock

Common stocks are the majority of the stocks that companies issue. What this stock holds which the preference shares don’t is the fact that the investor gets one vote per share during the company’s AGM(Annual General Meeting). Common stock holders only get the dividends(share of profits) if the company makes a profit and these securities are also one of the most riskiest because if the issuing company goes bankrupt then they would not be paid out. So it definitely carries issuer risk.

Preference stocks on the other hand do not come with the same voting rights and some do not give  any voting rights at all during the AGM. But the one advantage of preference stocks are that the dividend yield is guaranteed and is normally fixed.

They are also at an advantage because should the company go bankrupt, they would get paid before common stock holders but not ahead of the bond and debenture holders. Preference shares may also be called up by the issuing company and be bought out at any time and is purchased for a premium. Preference stocks are similar to a hybrid security which has qualities of both stocks and bonds.

Classes of stocks

Although this is uncommon, stocks can be put into classes. This is done so that the issuer can decide who gets the votes and give a select group of people the voting powers. These stocks can be broken down to Class A and Class B. The issuer can decide to award six votes per share for Class A voters and 3 votes per share for Class B voters. An example of this is the Royal Dutch Shell company which has two classes of stocks. Their ticker would say RDSA and RDSB.

(Stock certificate- proof of ownership of a stock)