A share is a single unit of ownership in a corporation or financial asset. Investors buy shares in a corporation and are then known as a shareholder.
If the corporation declares any residual profits these are then distributed to the shareholders in the form of dividends. In addition to dividends, investors may also receive capital gains if the value of the company increases.
Shares represent equity stock in a company, they are usually either common shares or preferred shares, for this reason, the terms stocks and shares are often used interchangeably. Most companies have shares but only the shares of publicly traded companies are listed on stock exchanges.
How a share works
Owners of a corporation may choose to issue preferred shares to investors and companies may issue equity shares to investors in return for capital investment, the investment is then used to grow and operate the firm.
Unlike finance obtained through a loan or bond issue, equity has no legal requirement to be paid back to investors and the shares. While they pay dividends as a way to distribute profits, they do not pay interest.
Almost every company, from small partnerships to LLCs and multinational corporations, issue some form of shares.
Shares of privately-held companies are initially owned by the owners or founders, although as they grow they may choose to sell shares to outside investors in the primary market.
This is often to friends and family but may also extend to angel or venture investors. As the company continues to grow it may want to seek further equity capital by selling shares to the public via either the secondary market or via an Initial Public Offering (IPO).
If the company goes the IPO route it would then become a publicly traded company and would be listed on a stock exchange. Historically, shareholders would be issued with a physical paper stock certificate, today these have been replaced with an electronic record of stock shares.
The issue and distribution of shares in both the public and private markets is overseen by the Securities Exchange Commission (SEC) and trading on the secondary market is overseen by SEC and FINRA.
Types of shares
As we previously mentioned, the two main types of shares are common shares and preferred shares. Typically, the majority of companies issue common shares. These types of shares provide shareholders with a residual claim on the company and its profits.
Common shares provide potential dividend and capital gain returns for investors and also come with voting rights, giving shareholders more control over the business in areas such as to elect members of the board of directors or approve issuing new securities or payments of dividends.
Certain common shares also include pre-emptive rights, meaning they give shareholders the right to buy new shares and retain their percentage of ownership when the company issues new stock.
In comparison, preferred shares do not generally offer much market appreciation in value or voting rights in the company. However, these types of shares do generally have set payment criteria and a dividend that is paid out regularly. For this reason, many investors consider preferred shares to have a lower exposure to risk compared to common shares.
Another factor that makes preferred share less risky is the fact that in the case of bankruptcy the company would be obligated to pay its preferred shareholders before common shareholders.
Advantages of shares
There are many advantages of investing in shares, including:
Partly own a company
Depending on the number of shares you hold, you will partly own the company you have bought shares in. Over time, if you increase your investment the greater that percentage will become and the better return you could receive.
Reinvest dividends or take income
Whether investors own common shares or preferred shares in a company they may receive regular dividend payments. These payments can be taken as either an income or investors can opt to re-invest to buy more shares.
Disadvantages of shares
The disadvantages of investing in shares include:
May become too concentrated
It is easy when investing in shares for investors to stick to one company, product type or industry, but that can lead to investments becoming too concentrated. It is much better for investors to diversify their portfolio to help protect against volatile markets.
You may make a loss
As with all investments, there is a chance or a risk that you could lose some or all of your investment. If the company underperforms or the market experiences volatility the value of your shares could decrease and may take a while to recover.