What is a Stock?

Key Takeaways:

  • Stocks are securities that represent a slice of ownership of a company.
  • Investors can classify stocks in several ways, including by sector, style or market capitalization.
  • Stock options can refer to contracts giving an investor the right to purchase or sell a security at a specified price, or they can refer to employee stock option plans.

Stocks are a common investment choice for many retirees. But what is a stock? If they are a part of your investment plan, it is important to understand what they are and how they work. Stocks are securities that represent a slice of ownership of a corporation. Corporations can sell stocks and other securities to raise capital. Stocks may also be referred to as shares or equities, and investors are often referred to as shareholders or stockholders.

Stock Basics

There are two main types of stock—common and preferred. Common stock gives investors the ability to vote at shareholder meetings. Preferred stock investors generally don't have the ability to vote at shareholder meetings, but they can have certain advantages over common stock investors. Preferred stock holders receive dividend payouts before common stock holders, and in case of liquidation or similar event, generally would be paid out prior to common stock investors.[i]

Both common and preferred stock investors can receive dividend income, which is a payment from the corporation to the shareholders. Dividends can be given as cash or additional shares. However, dividend income isn't the only way shareholders can benefit from owning a stock. A stock's benefit can also be seen in the increase of the stock price itself. If a shareholder sells shares that have appreciated in price, they profit from the difference between the current price and purchase price. Similarly, if a shareholder sells their shares for less than their purchase price, they incur a loss.

Shareholders

Shareholders, or stockholders, are simply the owners of a company's stock. There are different types of shareholders. A majority shareholder owns more than half of the company's stocks. A minority shareholder owns less than half. Any individual who owns common stock in a company is a shareholder. Some companies offer additional levels of share ownership. These may be denoted by classes (such as "Class A" or "Class B" shares), and different levels may have additional benefits.

Individual companies may provide different shareholder rights, but generally the rights involve the ability to vote on certain issues or for certain corporate elections, such as those for the board of directors. Shareholders generally do not have the ability to directly vote for executives or on smaller operational issues. Shareholder votes are usually tied to the number of shares the individual owns. A shareholder may also give their right to vote to a third party who will vote on their behalf.

Stock Classification

Stocks can be classified in several different ways. One way is by sector. Sectors are categories that group corporations by similar functions or industries. Sectors are a very general way of grouping similar companies, such as health care, utility or technology companies. Different classification systems exist for identifying which corporations belong to which sectors. Within classification systems there are often smaller groupings that identify companies with closer similarities. Sectors may react similarly to market influences, meaning it could be useful to know what companies belong to what sectors for investment decisions.

Another way to classify stocks is by investment style. Two main styles are value and growth. Growth stocks might offer greater capital appreciation potential by growing their earnings faster than the average company. Value stocks are those that may have greater potential for price appreciation, as they may be underpriced and poised to grow when the market reassesses their earnings' value.

Approximate size, or market capitalization, is another way to categorise stocks. Corporations' market capitalization can be calculated by taking the number of outstanding shares and multiplying it by the corporation's current stock price. Corporations may be referred to as small-cap, mid-cap, large-cap and even mega-cap based on their size. The exact values for these definitions can vary.

Investing in the Stock Market

Stocks may be purchased in several different ways. One way is directly from the company, often through a public offering. Another way is to go through a stockbroker. This may be an individual or a firm that facilitates buying and selling stock. Trading on the stock market most often incurs fees that can vary depending on how the trade was placed.

When analysing stocks, you may find it helpful to use common evaluation metrics, which include:

  • Earnings or Price-to-Earnings (P/E) ratio: This is calculated by taking the stock price of a company and dividing it by the company's earnings per share, or profit, for a specific period of time. This ratio can be used to determine how much a company is worth.
  • Earnings yield: This is the inverse of the P/E ratio. Earnings yield could be used to compare stock returns against other investments, such as bond yields, or cash-like investment yields such as money market funds.
  • Price-to-Book ratio: This ratio compares a company's current market price to its book value. A company's book value is the company's net equity, which can be calculated by subtracting the company's liabilities from its total net assets as stated on its balance sheet. A liability could be debt or other legal obligations. The Price-to-Book ratio can be calculated by dividing a company's market capitalization by the company's total book value.
  • Price-to-Sales (P/S) ratio: The P/S ratio is calculated by dividing the price per share by the annual net sales per share. This ratio can be used to calculate a stock’s value without using the company’s profits or earnings.
  • Dividend yield: This ratio expresses the amount that a company pays out in dividends each year relative to its share price. The ratio is the annual dividend divided by the current stock price.

Stock Options

Stock options are different than common stock. A stock option is a contract that allows investors to purchase or sell a specific security at a specified price during a certain timeframe. Stock options come in two types: call options and put options. Call options let the stock option buyer purchase the specified security, whereas put options let the stock option buyer sell the specified security. Stock option sellers are obligated to meet the terms of the options contract.

Trading stock options can be nuanced. If you are interested in buying or selling stock options, you may wish to consult with a financial professional for more information.

Stock options can also refer to employee stock options plan. These are different than options contracts. Employee stock option plans are offered by a company to its employees. An employee stock option plan usually has a specified price and time period in which the employee can purchase their company's stock. This type of stock option can be a part of a total compensation plan for employees.

Learning More With Fisher Investments Canada

Investing in the stock market may be an important part of your retirement income plan. However, understanding the nuances of the stock market is not always easy. Fisher Investments Canada may be able to help you with your retirement plan. Download one of our educational guides or contact us today to learn more.

[i] Source: U.S. Securities and Exchange Commission, as of 09/19/2019. https://www.investor.gov/introduction-investing/basics/investment-products/stocks

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid.
Past performance is no guarantee of future returns.