Understanding Stocks: How Stocks Work

A stock is a unit representing equity in a company or corporation. Owning stocks or shares of a company means owning a portion of it, and in turn, a claim on some of the company’s assets and earnings. The price of a stock is determined by a company’s assets and earnings per share, as well as predictions on the success or failure in the stock market.

Companies list their stocks in different stock markets or stock exchanges. Most major stock exchanges are located in the world’s financial capitals, like Nasdaq and the New York Stock Exchange on Wall Street in Manhattan, the London Stock Exchange in the City of London, and the Tokyo Stock Exchange in Japan.

Stocks are bought and sold through the stock exchange, which operates as a marketplace where companies can sell portions of the company to public investors, and public investors can negotiate prices for company stocks. This allows a company to accrue capital by selling shares of equity to the public, while shareholders can potentially gain a profit from a company’s growth.

A company or corporation becomes eligible to sell its shares on the marketplace after an Initial Public Offering, or IPO, which is when a private company opens for public trading. An IPO allows companies to maximize their financial resources as they grow. Buying stocks of a company—or investing—is essentially betting that the company will continue to grow.

Investing in company stocks doesn’t guarantee that the company—and your stocks—will grow in value. Investing in stocks always carries a degree of risk, because of market volatility.

There are two main types of stock, which are common stocks and preferred stocks.

• Common stocks: Common stocks give the shareholder voting rights, and the ability to influence company policy. There can be different classes of common stock in a public company, giving different voting rights based on the class of stock which common stockholders own. In a dual-class structure, where there are Class A and Class B stocks, Class A may have ten votes per share while Class B only has one vote per share. This enables a company's board of directors to better control the company.
• Preferred Stocks: Preferred stocks generally do not have voting rights. They are called preferred stocks because they carry benefits that common stocks don’t. For instance, preferred stockholders will be paid out before common stockholders in the event of a liquidation of assets—when a company stops business, and pays back its shareholders.

Owning shares in a company means that shareholders may gain or lose money based on how the value of their stocks change. As a company’s shares rise and fall in value on the stock market, a shareholder may either earn or lose money depending on when they decide to trade their stocks.

The two ways that investing in stocks may yield a profit to individual shareholders are through dividends (which are regular payments that a company makes to its shareholders, though not all stocks are dividend stocks), or through capital appreciation (an increase in the share price itself, allowing investors to sell shares at a higher price than they bought them).

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