To raise capital, companies offer ownership to market participants in the form of stock. A business can utilise such funds to finance new product lines, invest in business expansion, or pay down debt.
Let’s understand the meaning of stock in greater detail.
You will Learn About:
What is stock?
The ownership of companies can be broken down into units called ‘shares’, with each share representing the smallest unit of ownership in a company. Technically, ‘stock’ refers to the entirety of the shares of a company taken together.
Thus, in effect, a stock is a security that indicates that its holder owns a certain proportion of the entity issuing it. Investors buy company stocks to benefit from potential capital appreciation and receive dividend income. Stocks are generally bought and sold on stock markets.
More technically, shareholders cannot actually “own” parts of a company. Instead, what stocks technically represent are claims to a portion of a company’s assets and earnings.
Stocks have no maturity period and carry high risk, so SEBI has chalked out regulations to protect investors and other stakeholders from deceptive practices.
Stock: Quick Highlights
- A stock is a security that indicates that its holder owns a certain fraction of the issuing company and is typically traded on stock markets.
- There are two main types of stock offered to investors: common and preferred.
- Stocks have no maturity period and are relatively risky. They do not offer any guarantee on returns.
- Stocks differ from bonds in several key aspects.
Shareholders and equity ownership
When you purchase a stock, you purchase a small piece (often referred to as ‘equity’) of the issuing company. By doing so, you become a shareholder in the company.
Equity ownership in a company entitles you to many benefits. The most prominent of these is probably dividends. When a listed company (i.e. a company whose stocks are traded on the stock market) earns a profit, it may be distributed to shareholders in the form of dividends to reward their capital contribution. Shareholders may also be given voting rights in corporate matters.
In addition, shareholders reap the benefits of any capital appreciation (i.e. increases in the price of the shares). Such appreciation can help grow a corpus to meet your short-term and long-term goals. If shareholders sell their shares, they lose the ownership rights associated with them and are no longer entitled to the corresponding benefits.
Common vs preferred stocks
Common and preferred stocks differ on several grounds, some of which are listed below:
| Difference on the basis of | Common stocks | Preferred stocks |
| Voting rights | Common shareholders have voting rights. | Preferred shareholders do not have voting rights. |
| Access to profits and assets | Common shareholders do not have the first claim on assets or property. | Preferred shareholders have the first claim on profits and assets. |
| Payment of dividends | Common shareholders are paid dividends after preferred shareholders. | Preferred shareholders receive dividends first. |
| Bonus shares | Common shareholders are entitled to bonus shares in addition to their current holdings. | Bonus shares are not available for preferred shareholders. |
| Capital repayment | In the event of liquidation, common shareholders are not given preference. | When a corporation is liquidated, preferred shareholders are paid before common shareholders. |
| Convertibility | Conversion of common stocks is not possible. | Convertible preferred stock can be converted to common stock. |
Stocks vs Bonds
| Point of difference | Stocks | Bonds |
| Definition | When a company issues stocks, it offers ownership in exchange for cash. | When an entity issues a bond, it issues debt with the promise to pay the principal back along with interest. |
| Issuer | Corporations can issue stocks to raise funds to meet their business requirements. | Governments, municipalities, and companies issue bonds. |
| Status of the investor | Stocks represent ownership/ stake in a firm and entitle you to profits and dividends earned by the company. | Bonds, on the other hand, are a form of debt that a company or government draws from you, where returns are in the form of interest. |
| Risk level | The risk factor is high in stocks since the returns are not fixed or proportional. Dividends are not guaranteed. | Bonds have fixed returns making them less risky. The interest that is paid is fixed. However, with some bonds, the risk of default can be high. |
| Rights of the investor | Stockholders may have priority voting rights on significant issues. | Bondholders are creditors to the company and do not get voting rights. |
| Returns | The total return for a stock includes capital appreciation and dividend income. | Bonds provide monthly interest payments and principal repayment at the end of the term. |
| Marketplace | Stocks are listed in secondary markets, ensuring centralised trading | For bonds, trading is done Over the Counter (OTC). |
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Is investing in stocks risky?
The answer to this question is ‘Yes’. When investing in stocks, there are various risks to consider.
Firstly, stocks can be highly volatile and fluctuate in price rapidly. Stock movements are effectively impossible to predict. Secondly, there is no guarantee of returns. You could lose your entire investment amount.
Thirdly, many internal and external factors influence the functioning of a stock market. Even if a company is doing well, it may not be reflected in its stock price.
Conclusion
To sum up, a stock represents proportional ownership of a company’s equity. A corporation may issue stocks to raise funds from investors for new initiatives or to grow its current business. The rights and benefits of ownership are determined by the type of stock held by a shareholder. Do not forget that stock investments are risky. Consult your advisor before investing in stocks. Use Tickertape Stock Screener, which has 200+ filters to help you find the best stock according to various parameters.
