What it means
A company divides its ownership into units called shares, and the collective term for those units is stock. Buy 100 shares in a company with 10,000,000 shares outstanding and you own one hundred-thousandth of the business.
Ownership brings two possible returns: dividends, which are cash distributions out of profit, and capital growth if the share price rises. It also brings risk, because shareholders rank last if the company fails and can lose the whole investment.
Companies issue stock to raise money without borrowing, which is why the choice between issuing shares and taking on debt sits at the centre of financing decisions. Issuing more shares brings in cash but dilutes existing owners, spreading the same profit across a larger number of units.
Analysts value stock using per-share measures so that companies of very different sizes can be compared. Earnings per share, the price to earnings ratio and the dividend yield are the three most quoted, and all of them depend on the share count.
Common stock, called ordinary shares in the United Kingdom, carries votes and takes the full risk and reward. Preferred stock usually pays a set dividend ahead of common holders but often carries no vote, which makes it behave partly like debt.
The inventory meaning survives in everyday phrases such as stocktake, stock levels and out of stock, and in older British financial statements. Context almost always makes the sense obvious, but it is worth confirming when reading accounts prepared under different conventions.
In practice
Real-world examples.
Example
A founder sells 15% of her packaging business to an outside investor. The investor receives stock rather than a loan note, so there is no interest to pay, but the founder now shares every future profit and needs the investor's agreement on major decisions.
Example
An employee joins a listed retailer and is offered part of her package in stock. She notices that the shares trade at 28 times earnings, far above the sector average of 14, and treats the paper value with more caution than the cash element of the offer.
Example
A pension fund holds stock in 900 companies to spread risk. When one holding falls 40% after a profit warning, the fund's overall value moves by only a fraction of a percentage point, which is exactly the point of holding a wide spread.
Formula
Calculation
Market Capitalisation = Share Price x Shares Outstanding
Earnings per Share = Net Income / Shares Outstanding
Price to Earnings Ratio = Share Price / Earnings per Share
Take a listed engineering group with 20,000,000 shares outstanding trading at $45.00 a share. Its market capitalisation is $45.00 x 20,000,000 = $900,000,000.
The group reports net income of $60,000,000 for the year, so earnings per share are $60,000,000 / 20,000,000 = $3.00. The price to earnings ratio is $45.00 / $3.00 = 15, meaning investors are paying 15 times one year of profit for each share.
The board then declares a dividend of $1.20 a share. Total dividends come to $1.20 x 20,000,000 = $24,000,000, so the payout ratio is $24,000,000 / $60,000,000 = 40% and the dividend yield is $1.20 / $45.00 = 2.7%. The remaining $60,000,000 - $24,000,000 = $36,000,000 is retained in the business.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Aldenmoor Tools, an invented maker of garden equipment, had 4,000,000 shares outstanding held entirely by the founding family and reported net income of $2,000,000, giving earnings per share of $2,000,000 / 4,000,000 = $0.50.
To fund a new factory the fictional company issued 1,000,000 new shares at $8.00 each, raising 1,000,000 x $8.00 = $8,000,000. The family's stake fell from 100% to 4,000,000 / 5,000,000 = 80%, and earnings per share on unchanged profit dropped to $2,000,000 / 5,000,000 = $0.40.
Two years later the new factory lifted net income to $3,500,000, so earnings per share reached $3,500,000 / 5,000,000 = $0.70, comfortably ahead of the original $0.50. The family owned a smaller share of a considerably larger business, which is the trade every equity raise asks an owner to accept.
Watch out
Common mistakes.
- Confusing the share price with the value of the company, when only price multiplied by the number of shares outstanding gives market capitalisation.
- Reading the British and American meanings of stock as interchangeable, which can turn an inventory discussion into an equity one.
- Assuming stock ownership entitles you to a share of assets you can claim on demand, when shareholders rank behind every creditor if the business is wound up.
Questions
People also ask.
What is the difference between stock and shares?
In practice they are used interchangeably for company ownership, with shares referring to the individual units and stock more often used for the class as a whole.
Do all shareholders get a vote?
No, voting rights depend on the class of stock, and preferred or non-voting classes commonly trade a vote for a fixed dividend or a lower price.
Does a company receive money when its stock is traded?
Only when it issues new shares; everyday trading between investors on an exchange passes cash between them and none of it reaches the company.
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