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In the rabid, dust-swirling tussle to find the great stocks, it can sometimes be easy to lose sight of the big picture. Even for veteran investors, it never hurts to step back and reconsider the basics. And new investors absolutely need a good grasp on the fundamentals before diving face-first into the stock market melee.
In the coming weeks, I'll review the bedrock concepts of investing, starting today with a question that's just about as basic as it gets: What is a stock, exactly? And what do you get when you buy stock?
The piece of paper
In most cases these days, when you buy a share of stock, your broker will keep track of your ownership without actually sending you a physical certificate. However, imagine for a moment that you're holding a fancy piece of paper with regal pictures, a serial number, the company's logo, and the signatures of the company's officers. This is a share of stock.
A share of stock certifies that you are a part-owner of the company. As such, you're entitled to certain things.
Pies R Us
Imagine a very simple business -- say, you and your daughter selling pies. (Pies are in for 2011!) You've put up all of the capital for the business, but you aren't going to do much of the work, so the two of you decide to split the company 50/50. To make it official, your daughter draws up two stock certificates, and you each hold onto one.
In this case, your share of stock means that you lay claim to 50% of the profits of the company. It also means that you have a crucial vote when it comes to making major decisions for the company, such as whether the profits should be pocketed or spent on ingredients for more pies, or whether the company should focus on sweet confections or diversify into savory tarts.
The public markets
In many ways, you can think of owning stock in a public company just as simply as the example above. Each share of stock you buy in a company grants you a certain percentage of that company. Through that ownership, you lay claim to a portion of the company's profits, and you get a proportionate number of votes when corporate voting matters arise.
Of course, when you own stock in a public company, the ownership percentage is typically very small. In practice, this means that most investors end up largely passive -- laying claim to their share of the profits, and trusting the current board of directors and management with the direction of the company. It's still possible for you to make an impact on how the company is run, but it's much tougher for someone owning five shares than for an investor who owns 50% of the company.
Still, no matter how little you own, you're still an owner of the company. Many of the best investors -- such as Warren Buffett -- make their investments with an owner's mindset. They're not buying a piece of paper; they're buying the company behind it.
What you will actually own
In practice, investors often consider company measures on a "per share" basis -- the amount to which each share is entitled. Stocks are priced on a per-share basis, meaning that when you see the price for a stock, that's generally how much it costs to buy a single share. Earnings per share denote the portion of the earnings that theoretically belong to each share that a shareholder owns. I say "theoretically" because the company decides how this money is used, and it may or may not be paid out to you immediately.
Dividends per share, however, are actual cash payments made to you -- typically every three months, a period known as a "quarter." Meanwhile, cash per share denotes the amount of cash the company holds, which it can eventually either invest in hopes of boosting earnings per share, or give back to shareholders.
Let's examine what this means for a group of major public companies:
Price Per Share
Ownership Per Share
Earnings Per Share
Dividends Per Share
Cash Per Share
Source: Capital IQ, a Standard & Poor's company and Yahoo! Finance.
Earnings per share = trailing-12-month total.
Each stock above gives the holder a certain percentage ownership in the company in question. But as the table shows, what that ownership entails can vary considerably from company to company. Netflix has far fewer shares outstanding than Exxon, so each share represents a much larger ownership stake in the company. AT&T pays its shareholders a dividend each quarter and doesn't hold much cash, while Apple opts to hold a significant amount of cash and pay no dividend.
With any luck, you now have a better sense for what you're actually buying when you invest in a stock. In the articles ahead, I'll explore the reasons why you would decide to buy (or ignore) a particular stock.
In the meantime, feel free to head down to the comments section and pepper me with questions, or offer suggestions for what you'd like to learn in the rest of this series.