By elmads

Investing in the stock market are one of the ways to increase our wealth.

It is by investing and trusting our hard-earned money into companies that we deem will make our money grow in the long run, based on our investing strategies and principles.

It is also a way for average investors like us to be part owners of large companies of worldwide such as Apple, Amazon, Google, Microsoft and many more.

Shares

Shares are a proof of ownership in a company. Investors trade their money for a share or shares of a company in the expectation to have a better gain on their initial invested capital. You might ask why do companies do this? well they do it for one specific purpose, which is to raise money to expand and grow their company and its business operations.

Remember that companies are built to improve humanity’s life in producing and innovating world changing goods and services, to spur growth of their country’s economy, while being profitable at the same time. I know this sounds perfect but this is true, each and every company has a mission and vision which summarize into these three. Nevertheless, some of these companies have other priorities than what I have previously stated, but I will not dig deeper into that because it is a topic of its own.

Moving forward, directors and existing owners of a company decide to further breakdown the ownership of the business in order to raise capital. This breakdown of ownership are referred to shares, which will be sold into the capital markets where institutions and individual investors like us, buy and sell the said shares. I have explained this method in details, in my blog titled “How shares are made and how the Stock Market works”.

In addition, it is also important that investors know the 4 key words in a company’s share. As companies decide to go public and break it down into shares, they also need to decide the following;

Fistly, Authorized shares This is the maximum number of shares that a company can legally issue and offer either to the public and employees. This is the 1st and foremost number of shares that the owners of the company will be deciding.

Secondly, Shares Outstanding of the company. This is the total breakdown of the company ownership that can be issued publicly.

Thirdly, how many or what percentage of the shares outstanding will be restricted to the company itself, for its employees only. This is called Restricted Shares of a company. In here, the company will set aside a certain number of shares to be given usually as incentives to their employees to spur loyalty. For instance, some public companies give a certain amount of shares of their company after a service of 5 years. The plus side of this incentives are the compensation it can have when the company’s stock market price appreciates over time – it is also for the additional benefits of the employee. Restricted shares are a part of Shares Outstanding, but is not available for trading in the stock market, as the name implies.

Lastly, how many or what percentage of the shares outstanding will be sold in the public. This is called the Public Float. These are the shares that are readily available to be traded in the stock market. It is also a portion of the Shares Outstanding of the company.

Below is a clear representation of the 3 terms, excluding the authorized shares.

To give you context I’ll show you Netflix’s shares breakdown as per 04/01/2021

Now that I have presented the basics of a share. I’ll now explain it further with an analogy based on our daily lives. Let’s say we have a company, we decided to raise capital by breaking down the company’s ownership and selling these shares to investors. So, the representation of our company is the 1 whole pizza then the rest is as follow below;

• Our Private Company = 1 Whole Pizza
• 1 share of the company = 1 slice of pizza

We then decided to make 8 shares of our whole company and make it into a public company

• Total Company shares/Authorized shares (8) = Total Slices of our 1 whole Pizza (8)
• Shares Outstanding (6)
• Restricted Shares (2) = our family members (2 slices of pizza)
• Public Float (4) = Friends (4 slices of pizza)

After we have decided that the pizza will be sliced into 8, we will then give out 6 slices of pizza to both our family members and friends, while the remaining 2 slices will be stored.

We determine that we will be giving the 2 slices of pizza to our family members and this cannot be given to others.

Moreover, we have decided that the remaining 4 slices of pizza will be given to our friends. We do not care if our friends will eat it or just give it to others. Nonetheless, we can still get a slice of the pizza we gave to our friends as long as some of them are willing to give it back to us. That is the simple breakdown and gist of shares and how it works.

For a better explanation with visuals, see my made infographics about the Pizza Analogy.

See blog links below to know more about:

• Beware of Share Dilution
• Share Buyback & Dividends

Stocks

This is a slice of ownership of one or more companies. There has always been a misunderstanding of both shares and stocks. Shares are a slice of ownership of a PARTICULAR COMPANY, whereas stocks are an ownership of VARIOUS COMPANIES. Technically speaking, shares represent a unit of a stock. When people say that they own a share, the next question is always “share of what? is it a company, a mutual fund, limited partnerships or others?” whereas when you pertain to stocks it automatically translates to an ownership of securities of different companies that are being traded in the stock market. For instance, I own stocks in both the UK and US, whereas I own shares of company XYZ.

Company stocks have two basic forms which are Common Stock and Preferred Stock.

• Common Stock – these are the ownership of different corporation in which investors like us, commonly invest in. In addition, Most stocks are issued in this form. In here, investors have the voting rights to make decisions for the company.
  
  Take note, before investors are able to exercise the said voting rights they need a significant amount of shares of the company. This will depend on the company itself, as some companies grant each of their common stockholders 1 vote for every share they have.
  
  Nevertheless, most investors do not invest for this specific purpose, especially with individual investors like us. The main reason in investing into a common stock is for capital appreciation and dividends gains.

As a common stockholder we have the rights to the company’s earnings. If the company grows, they can then give dividends (which is part of the company’s earnings for that year) to their investors. The dividend pay-out to the common stockholders will always depend on the directors of the company and the company’s performance.

The downside of investing in a common stock is, when the company goes under and undergo bankruptcy. The common stockholders will be the last one to receive payments from the company’s assets. In the worst case scenario, they’ll not even receive a penny in the company, which is usually the case.

Common stocks are for investors who are seeking high returns of investments with added income via the company’s dividends.

• Preferred Stock – it is also an ownership of shares of a company or companies. This is an unpopular investment for most investors because it works mostly like a bond rather that a stock. “What do I mean by this?” preferred stocks are entitled to receive a fixed amount of dividends from a company just like bonds. Though unlike bonds, preferred stocks can still have capital appreciation but with low to almost none at all.

In conjunction, preferred stocks have added protection compared to its brother, the common stock. Firstly, they have the priority to always receive the dividends of the company compared to the common stockholders. In fact, the dividends are mostly fixed with preferred stocks. Secondly, if the company goes into bankruptcy, preferred stockholders will be receiving first a piece of the company’s assets or the money, before the common stockholders.

The disadvantage – preferred stockholders have no voting rights in the company, have very limited to no capital appreciation, can also not receive any dividends from the company (usually when the business is in a tight financial situation).

Preferred stocks are for investors who are seeking stability in the future of their cash flows.

To Sum It Up

Owning stocks and shares does not mean that we own the company as a whole. We do not own any properties in the company, do not go in the company and act like the boss, or feel like a significant person, or as if you have an entitlement in all of its assets including its employees. Just to make it clear! what we investors own are a portion of the company’s earnings.

You read it right just the earnings itself. If the company expands and grows, our invested capital will do so as well, but if the company declines or goes out of business, then so does our invested capital.

This is the reason why, as much as possible, learning the whole framework, structure and context of the company is important in investing. This gives us the stability and confidence in our decisions, in investing our money into a specific company, and to mitigate the risk of panicking when stock prices go south. As like Warren Buffet has said:

“The best investment you can make is an investment in yourself. The more you learn, the more you earn.”

Warren buffet

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.