Back to the Basics: What Is a Stock?

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:

Company

Price Per Share

Ownership Per Share

Earnings Per Share

Dividends Per Share

Cash Per Share

ExxonMobil $78.50 0.00000002% $5.65 $1.76 $2.43
Apple $326.72 0.00000011% $17.92 $0 $29.28
AT&T $28.33 0.00000002% $3.68 $1.72 $0.55
Starbucks $33.20 0.00000013% $1.24 $0.52 $1.55
Netflix $182.09 0.00000191% $2.64 $0 $4.91

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.

Apple, Netflix, and Starbucks are Motley Fool Stock Advisor recommendations. The Fool has written puts on Apple. The Fool owns shares of Apple and Exxon Mobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of AT&T, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool’s disclosure policy prefers dividends over a sharp stick in the eye.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2011, at 10:49 AM, galgotcat wrote:

    How about "What Is a Bond"?

  • Report this Comment On January 25, 2011, at 12:46 PM, hrse wrote:

    excellent. After you are done this, how about, something if even an low low low level introdution to real estate investing.

    If not, the difference types of certificates that get traded: REIT, Stocks, iShares, ETF, etc

  • Report this Comment On January 25, 2011, at 6:18 PM, Slainte17 wrote:

    How about explaining what happens when a company buys back stock. I understand the shareholder benefits assuming the stock is undervalued, but how does a company buy the stock? Who do they buy it from? etc.,

  • Report this Comment On January 26, 2011, at 1:45 PM, vivvie1 wrote:

    So, what happens to my piece of paper when the stock market melts? If its value goes from $32.00 to 2 cents, it's still a valid share and if I hold onto it long enough, the company might make a comeback and the value will increase?

    Also, why is it that some times stock prices drop significantly, but I still have gains to report and pay taxes on?

  • Report this Comment On February 03, 2011, at 7:26 PM, TMFKopp wrote:

    @vivvie1

    "So, what happens to my piece of paper when the stock market melts?"

    Your piece of paper will still (likely) mean the same thing. That is, you'll still be a claimant on the company's earnings and you'll get paid when the company issues a dividend. If the market simply goes nuts and drops the price of the stock, you can still feel fine because you own just as much as you did prior to the stock dropping. This is even better if dividends are part of the picture since they'll keep rolling in as before.

    The question, of course, is whether the stock was reasonably valued when you bought it. If it was, there's a good likelihood that the price will come back. If, however, you paid too much for your share, the price may never (or at least not for a long time) return to what you paid for it.

    Where this picture might differ is if the stock market melts down because of a severe and lasting recession that depresses the performance of publicly-traded companies. Your shares may now entitle you to the same share of profits, but that may now be a lower profit.

    And in some cases, a company may feel that it needs more money in the coffers to keep the business running and it could issue new shares to get that money. In that case, the new shares issued will reduce your ownership stake in the company.

    One of the keys to being a good investor is recognizing when a stock has fallen for no good reason (and therefore may be a good buy) versus when a stock has fallen for perfectly good reasons (and then may be a sell).

    That's a little long winded, so feel free to fire away with more questions if that's not clear to you.

    "Also, why is it that some times stock prices drop significantly, but I still have gains to report and pay taxes on?"

    Alas, I can't really comment on your individual finances since I don't have all the information. If you feel like providing more details, I may be able to provide some general thoughts on why that may be happening.

    Matt

  • Report this Comment On February 03, 2011, at 7:27 PM, TMFKopp wrote:

    @Slainte17

    "How about explaining what happens when a company buys back stock. I understand the shareholder benefits assuming the stock is undervalued, but how does a company buy the stock? Who do they buy it from? etc.,"

    Good one! I'll try to work that into a future article.

    Matt

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