Stock refers to a share – or small piece – of a publicly-owned company. When you own stock in a company, you are a partial owner of that company. When that company makes money and distributes profits to its owners, all the stock owners (called “stockholders”) get a piece of that profit.
When you buy stock in a company, you pay a “share price.” This is the price at which someone who currently owns the stock is willing to sell it to you. Once you own the stock, you can sell whenever you would like to (with some restrictions). If the company grows and becomes more successful while you own the stock, other people may be willing to buy your shares for a higher price.
A share of stock has value because (1) it represents partial ownership in all the assets and products that a company holds and (2) it entitles the stockholder to a share of future profits of the business. If the future prospects of a company improve, the stock price will likely go up because the future profits of the business are expected to be higher.
How do stocks work?
Let’s start from the beginning. If Jane Doe starts a company and does not borrow any money from friends, family, or banks to start it, then she owns 100% of the company. As the company grows and grows, she may give “equity” – or ownership in the company – to key employees in exchange for their hard work or to investors in exchange for cash. Every year, Jane takes all the profit from the business and splits the money into two piles: one pile is reinvested in the company and the other pile is distributed to the owners of the company. The distributed amounts are called “dividends.” If an individual owns 25% of all the stock in the company, that individual will receive 25% of the total dividends paid out.
At a certain point, Jane wants to take her company “public.” This means that individuals and organizations will be given the opportunity to buy and sell shares of the company to each other. If Jane wants to sell some of her shares, the just goes to a marketplace called a “stock exchange” where there are people who want to buy shares of her company. Jane will sell her shares to the highest bidder and exchanges those shares for cash. The price she sells at is the “share price” and the new owner of those shares is entitled to the future dividends for those shares.
How do I buy stock?
Usually, you need to buy stock through a broker or brokerage firm. These are people that have special licenses to buy and sell stocks on stock exchanges (i.e. the “stock market”).
If you want to buy a stock, you start an account with a brokerage firm and transfer in money. Once you have money in your account, you can buy shares of any company available as long as you have enough money in your account. When you make your decision, you use your broker’s website or call them to have them purchase a specific amount of shares in a specific company. Once they do that, you own the stock!
While you own the company, every quarter or every year the company will usually pay a “dividend”, or a share of the profits from that time period. You will receive a proportionate amount of dividends to the amount of shares you own (i.e. the more shares you own, the more money you will receive in dividends). The company will issue that money directly to your brokerage account, where you will either receive the money in cash or reinvest the money in more shares of that company.
When you want to sell, you just use the brokerage firm website or call your broker, and have them sell the shares you want to sell. You can sell one, several, or all the shares you own – it is completely up to you. If you sell for a higher price than you bought the stock at originally, you just made money!
It is important to note that you can own shares of a privately held company – say, a family business – without the stock market. That’s not what we’re talking about here. Most companies are “privately held”, which means you cannot buy their shares through the stock market. When you hear about investing in stocks, that is usually referring to public company investments.
How do I make money with the stock market?
There are two main ways that you can make money in the stock market:
- You receive dividends for the stocks you own;
- You sell stocks for a higher price than you bought them for.
This is important – you do not need to sell your stocks in order to make money from them. If you hold a stock for years and it consistently pays a dividend, you will get an ongoing benefit from owning that stock without having to sell it.
There are also tax implications for the money you make from stocks. Generally, any money you make from stock investments is taxable. Dividends are either treated as earned income or given a special preferential tax rate, depending on a few factors. When you sell a stock, the profit you made (i.e. the difference between what you paid for it and what you sold it for) is called a “capital gain.” Depending on another few factors – including how long you owned the stock – you may different tax rates on those capital gains.
