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What Is Stock?
A Beginner's Guide to Understanding and Investing in Stock

By Joshua Kennon, About.com Guide


History has shown that owning stocks is one of the easiest and most profitable ways to grow your wealth over the long-term. Virtually every member of the Forbes 400 list got there because they own a large block of shares in a public or private corporation, ranging from manufacturing and oil drilling to cosmetics and money management. Although your beginning may be humble, this guide to investing in stocks will explain what stocks are, how you can make money from them, and much more.

Shares of Stock Represent Pieces of a Business
Imagine you wanted to start a retail store with members of your family. You decide you need $100,000 to get the business off the ground so you incorporate a new company. You divide the company into 1,000 pieces, or "shares" of stock. (They are called this because each piece of stock is entitled to a proportional share of the profit or loss). You price each new share of stock at $100. If you can sell all of the shares to your family members, you should have the $100,000 you need (1,000 shares x $100 contributed capital per share = $100,000 cash raised for the company).

If the store earned $50,000 after taxes during its first year, each share of stock would be entitled to 1/1,000th of the profit. You'd take $50,000 and divide it by 1,000, resulting in $50.00 earnings per share (or EPS as it is often called on Wall Street). You could call a meeting of the company's Board of Directors (these are the people the stockholders elected to watch over their interest since they couldn't run the business) and decide to use the money to pay cash dividends, repurchase stock, or expand the company by reinvesting in the retail store.

At some point, you may decide you want to sell your shares of the family retailer. If the company is large enough, you could trade on a stock exchange. That's what is happening when you buy or sell shares of a company through a stock broker. You are telling the market you are interested in acquiring or selling shares of a certain company and Wall Street matches you up with someone and takes fees and commissions for doing it. Alternatively, shares of stock could be issued to raise millions, or even billions, of dollars for expansion. When Sam Walton formed Wal-Mart Stores, Inc., the initial public offering that resulted from him selling newly created shares of stock in his company gave him enough cash to pay off most of his debt and fund Wal-Mart's nationwide expansion.