Stocks: owning a slice of a company

A share of stock is a small piece of a company

Welcome. You don't need to know anything about investing to start here. We'll go one small step at a time. What is a stock, really? A share of stock is a small piece of ownership in a company. If you own a share, you own a slice of that business.

Picture your friend Maya. She's opening a pizza shop, and she needs 10,000 dollars for ovens. She splits the shop into 100 equal pieces and sells each one for 100 dollars. You buy 10 of them.

Those pieces are shares. With 10 of the 100, you own 10 percent of the shop. That makes you a shareholder, which means a part owner. Big companies do the same thing, with millions of shares. Anyone who buys one becomes a part owner.

Owners of common stock also get a vote. They elect the board of directors, the group that oversees the company. One mix-up trips people up. They think a stockholder lent the company money. Lending is what bondholders do, and you'll meet them soon.

Keep this one idea. A share of stock is a small piece of ownership in a company.

Owners share in the profits, the price and the risk

You own a stock. How does that make you money? There are two ways, and one big risk. A share is a small piece of ownership in a company. The first way to earn is a dividend. A dividend is a payment to the owners out of profits.

Say Maya's pizza shop pays 5 dollars a share this year. Your 10 shares bring you 50 dollars. A dividend is never promised. The board of directors decides whether to pay one.

The second way is the price. If the shop does well, people pay more for a share. Sell for more than you paid, and you gain. Prices fall too. If the shop struggles, your share is worth less than you paid.

Here's the big risk. If a company fails, it sells what it has and pays people in order. Lenders come first. Common stockholders come last, and often get nothing. People get this backward. They think owners come first because they own the company. Owners come after everyone the company owes.

A share is a small piece of ownership in a company. Owners share in the profits and the risk, and they're paid last.

Worked example: price gain plus dividends

1. An investor buys 100 shares at 40 dollars. Later she sells them all at 46 dollars. Along the way she got 2 dollars a share in dividends. What did she make in total?
2. Start with what you know. Owners make money two ways, from the price and from dividends. So we'll count both.
3. Step one is the price gain. She paid 40 and sold at 46, so each share gained 6 dollars.
4. She had 100 shares, so multiply. 6 dollars times 100 is 600 dollars from the price.
5. Step two is the dividends. 2 dollars a share times 100 shares is 200 dollars.
6. Step three, add the two together. 600 plus 200 is 800 dollars. That's her total return.
7. The usual slip is stopping at 600 and forgetting the dividends. Count the price gain and the dividends every time.

Common mistakes

A stockholder is an owner, not a lender

You treated a stockholder like a lender. A stockholder owns a piece of the company. Lending, with set interest and a date to be paid back, is what bondholders do. Stock comes with no promised interest and no payback date. Owners take the ups and downs.

When a company fails, owners are paid last

You put the owners ahead of the lenders. The order runs the other way. When a company fails, everyone it owes money to is paid first. That includes bondholders, banks and suppliers. Common stockholders are paid last. Lenders are paid before owners, every time.

Total return counts dividends too

You counted the price gain and left out the dividends. Owners make money two ways. Add the price gain to the dividends: 600 plus 200 is 800 dollars. Total return is the price gain plus the dividends.