How stocks work and what a share represents

A share of stock is a unit of ownership in a company. Owning one share makes a person a part owner of that business, with a claim on its assets and earnings in proportion to the total number of shares outstanding. A holder of 1,000 shares in a company with 1,000,000 shares outstanding owns one-tenth of one percent of it.

Buying a share usually means buying from another investor on a stock exchange, not from the company itself. The company generally receives money directly only when it issues new shares. The price that changes hands afterward is a transaction between investors. That distinction is easy to miss, because a share's price is widely reported and the company's name is attached to every trade.

How companies issue shares

Companies issue shares to raise equity capital, which is money that does not have to be repaid the way a loan does. The money may fund new equipment, expansion, research or the repayment of debt. A company's first sale of shares to the public is commonly called an initial public offering. Later sales of new shares, often called follow-on offerings, can raise more money, but they also increase the number of shares outstanding. Each existing share then represents a smaller percentage of the company, an effect known as dilution.

Companies can also buy back their own shares, which reduces the number outstanding. The effect on each remaining shareholder depends on the price paid and on what the company does with its cash.

Some companies also change the number of their shares without raising or returning cash. A stock split divides existing shares into more pieces, and a reverse split combines them into fewer. Each change alters the number of shares and the price per share in the same proportion, so a holder's percentage of the company stays the same. A lower share price after a split does not by itself mean a stock has become cheaper.

What shareholders own and what they can vote on

Shareholders hold a residual claim on the company. Lenders and other creditors are paid before shareholders, and if a business is liquidated after bankruptcy, shareholders typically receive whatever remains after those claims are settled, which is often nothing. Ownership also comes with limited liability. Most shareholders of a public company generally cannot lose more than the amount they invested, even if the company owes more than its assets are worth.

Common shareholders usually have voting rights on significant matters, such as electing the board of directors and approving certain major transactions. Many shareholders cast these votes by proxy rather than attending meetings. Preferred shares are a different class. They often have a higher claim on dividends and assets than common shares, but usually have limited or no voting rights. The exact rights are set out in the company's governing documents and in the terms of each share class.

Where a shareholder's return comes from

A shareholder can earn a return in two main ways. The first is dividends, which are payments the board decides to distribute from profits. Dividends are not guaranteed, and a company can reduce or stop them. Many companies reinvest earnings instead, which can support growth but provides no cash payment to holders. The second is a change in price. If a share is sold for more than its purchase price, the difference is a capital gain. If it is sold for less, the difference is a capital loss.

Both sources depend on the business. A company that earns steady profits may pay dividends or grow its value over time, while a company that loses money can see its share price fall and its dividends suspended.

Total return combines both sources. A holder who received dividends over a period and also saw the price change has earned a return that includes both parts. Looking at price alone can make a stock that pays a steady dividend appear to have done worse than it did, so comparing the two parts separately gives a fuller picture.

What shareholders can and cannot expect

Shareholders can expect to be treated according to the rights of their share class, to receive the information the company is required to publish and to share in profits or losses in proportion to their stake. They should not expect a fixed payment, a guaranteed price or a say in day-to-day operations. A shareholder typically has no right to require the company to buy back its shares at a set price, and the price of a share can fall far below what was paid.

Companies whose shares trade on major exchanges generally must publish financial reports and certain disclosures on a regular schedule. Reading those documents, including the risk factors section, helps investors understand what could go wrong. A single share is a claim on a business, and its outcome depends on how that business performs and on what other investors are willing to pay for it. Understanding the rights attached to a share and the sources of return is a necessary first step before making any decision. For choices about individual companies or about how much to place in individual stocks, a licensed financial adviser can help weigh the trade-offs against personal goals.