What is a stock? Ownership, shares and why prices move

A stock, also called a share or an equity, is a unit of ownership in a company. When you buy one share of a corporation, you own a small fraction of that business and have a claim on part of what it earns. Understanding what a share really is helps you separate a company's long-term value from the day-to-day noise in its price.

What a share represents

A corporation is a legal entity that can own assets, sign contracts and owe debts in its own name. Its ownership is divided into shares. If a company has 1,000,000 shares outstanding and you hold 1,000 of them, you own 0.1% of the company.

Owning a share does not give you a claim on any particular office or machine. It gives you a claim on the company as a whole, after everyone else has been paid. Lenders, suppliers, employees and tax authorities come first. Shareholders are the residual claimants: they receive what is left, which can be a lot or nothing.

Shareholders also get limited liability. If the company fails, you can lose the money you invested, but creditors cannot come after your personal assets for the company's debts. Your downside is capped at what you paid, while your upside is not capped.

What owning a share gives you

Rights vary by share class, but ordinary shares usually carry these:

• A claim on earnings. The company can pay profits out as dividends or reinvest them to grow. Reinvested profits can raise the value of each share over time.
• Voting rights. Most common shares carry votes on matters such as electing the board of directors. Some companies issue shares with different voting power, which is covered in dual-class shares.
• A claim on assets in liquidation. If a company is wound up, shareholders are paid last, after creditors and any preferred shareholders. The differences are explained in common vs preferred stock.

How investors earn a return

There are two basic sources of return from a stock:

1. Price change. You sell for more than you paid (a capital gain) or for less (a capital loss).
2. Dividends. Some companies pay part of their profits to shareholders in cash, usually every quarter. Many growth-focused companies pay none and keep the cash inside the business.

Neither source is guaranteed. A company can cut or suspend a dividend, and its share price can fall and stay down for years.

Why stock prices move

A share price is the most recent price at which a buyer and a seller agreed to trade. The mechanics of that meeting are described in how the stock market works. What pushes the agreed price up or down is a change in how the market values the company's future prospects.

A simple way to think about it: the price reflects what investors collectively expect the company to earn in the future, adjusted for how risky those earnings look and for what else they could do with their money. Several kinds of news shift those expectations:

• Company news. Quarterly results, new products, management changes, lawsuits or a change in the company's forecasts.
• Industry and economic news. Changes in interest rates, inflation, consumer demand or regulation can affect whole groups of stocks at once.
• Sentiment and flows. Even without news, large buy or sell orders, shifts in mood or forced selling can move a price in the short run.

Over short periods, prices can swing for reasons that have little to do with the underlying business. Over long periods, prices tend to follow the earnings and cash flows a company actually produces, although that link is loose and can be slow.

Example (illustrative numbers)

Imagine a company with 10 million shares outstanding trading at $40. Its total value in the market is $400 million (price times shares, see market capitalization).

Next quarter the company reports profits well above what investors expected, and buyers now agree to pay $44 per share. The share price rose 10%, and the market value of the company rose to $440 million. Nothing about the shares themselves changed. Only the market's view of the company's prospects did.

If the company had instead split each share into two, there would be 20 million shares at $20, and the total value would still be $400 million. A change in the number of shares or the price per share does not by itself change what you own (see stock splits and reverse splits).

Common mistakes and limits

• Confusing a low price with a bargain. A $5 stock is not cheaper than a $500 stock in any meaningful sense. Value depends on what you receive for the price you pay, such as earnings or cash flow per share, not on the dollar price per share.
• Treating a rising price as proof of quality. Prices can rise for reasons that fade. Looking at the business, not only the chart, is what separates investing from guessing.
• Forgetting the order of claims. In a bankruptcy, common shareholders are last in line and often receive little or nothing.
• Expecting a smooth path. Even good companies can see their shares fall sharply for months. A stock is a risky asset by nature.

Where to see it on StocksXray

Every stock page, such as Apple or Microsoft, shows the price chart, the fundamentals behind the business, and the dividend and split history. The S&P 500 page lists the companies in the research universe.

Key takeaways

• A share is a fractional ownership claim on a company, and shareholders are paid after creditors.
• Limited liability means your loss is capped at what you invested.
• Returns come from price changes and from dividends, and neither is guaranteed.
• Prices move when expectations about future earnings, risk or demand change, and also for short-term reasons unrelated to the business.
• The dollar price per share says nothing by itself about whether a stock is cheap or expensive.

This article is educational and is not investment advice.