What is a stock?

A stock or share (also known as a company's "equity") is a financial instrument that represents ownership in a company or corporation and represents a proportionate claim on its assets (what it owns) and earnings (what it generates in profits). Stock can be bought and sold privately or on stock exchanges, and such transactions are typically heavily regulated by governments to prevent fraud, protect investors, and benefit the larger economy. The stocks are deposited with the depositories in the electronic format also known as Demat account. As new shares are issued by a company, the ownership and rights of existing shareholders are diluted in return for cash to sustain or grow the business. Companies can also buy back stock, which often lets investors recoup the initial investment plus capital gains from subsequent rises in stock price. Stock options, issued by many companies as part of employee compensation, do not represent ownership, but represent the right to buy ownership at a future time at a specified price. This would represent a windfall to the employees if the option is exercised when the market price is higher than the promised price, since if they immediately sold the stock they would keep the difference (minus taxes). In general, the shares of a company may be transferred from shareholders to other parties by sale or other mechanisms, unless prohibited. Most jurisdictions have established laws and regulations governing such transfers, particularly if the issuer is a publicly traded entity. The desire of stockholders to trade their shares has led to the establishment of stock exchanges, organizations which provide marketplaces for trading shares and other derivatives and financial products. Today, stock traders are usually represented by a stockbroker who buys and sells shares of a wide range of companies on such exchanges. A company may list its shares on an exchange by meeting and maintaining the listing requirements of a particular stock exchange. In the United States, through the intermarket trading system, stocks listed on one exchange can often also be traded on other participating exchanges, including electronic communication networks (ECNs), such as Archipelago or Instinet. Many large non-U.S companies choose to list on a U.S. exchange as well as an exchange in their home country in order to broaden their investor base. These companies must maintain a block of shares at a bank in the US, typically a certain percentage of their capital. On this basis, the holding bank establishes American depositary shares and issues an American depositary receipt (ADR) for each share a trader acquires. Likewise, many large U.S. companies list their shares at foreign exchanges to raise capital abroad. Small companies that do not qualify and cannot meet the listing requirements of the major exchanges may be traded over-the-counter (OTC) by an off-exchange mechanism in which trading occurs directly between parties. The major OTC markets in the United States are the electronic quotation systems OTC Bulletin Board (OTCBB) and OTC Markets Group (formerly known as Pink OTC Markets Inc.) where individual retail investors are also represented by a brokerage firm and the quotation service's requirements for a company to be listed are minimal. Shares of companies in bankruptcy proceedings are usually listed by these quotation services after the stock is delisted from an exchange.

OVERVIEW OF STOCKS

• Growth stocks
  These are the shares you buy for capital growth, rather than dividends. Growth stocks are essentially shares in those companies that are generating positive cash flows and whose earnings are expected to grow at an above-average rate relative to the market. It’s worth remembering that some of the most successful firms in the US economy pay out relatively miserable dividends, such as Warren Buffett’s Berkshire Hathaway. If anything, they are the equivalent of a real estate investment. You buy and hold, riding the appreciating value of the asset. For the first few years you may not make much on the shares but if you hold onto them for long enough, and good quality managers avoid the pitfalls along the way, you’ll be well looked after when other investors hop on board at higher prices. An example in Australia is CSL, the old Commonwealth Serum Laboratories. The shares are only yielding 1.62 per cent a year in terms of dividends but long term holders aren’t complaining. The former Government laboratories were privatised in 1994 at $2.30 a share and the shares have since gone up by a factor of more than 45 times. They broke through $100 in December and are now around $107 each. It is lucrative, but it’s not easy: buying shares early in growth companies is the Holy Grail of investing and they are even harder to find when the stock market is booming. In bull markets, you can go the way of identifying successful companies with strong growth prospects and calculating what you’d like to pay for their shares. Then wait for the inevitable market pullback that brings the share price to your range.



• Dividend aka yield stocks
  Yield stocks, ideally, are those that perform well in bull markets while providing partial downside protection for investors in bear markets. They are the stocks of choice for the income-seeking investor. The stock yield is calculated by dividing the yearly dividends paid by the company to the company’s share price. For example, if a company is expected to pay out $0.50 in dividends over the next year and is currently trading at $20, the dividend yield is 2.5%. It is because of their dividend yield that the four big banks and Telstra account for well over half of retail investors’ shareholdings in Australia. They have been sold down since late last year on the reasonable basis that the economic outlook is not rosy, but they’re not going out of business any time soon. ANZ’s weak half year profit result last week saw the six month dividend cut from 95c to 80c, but a recovery in the share price on Budget Day, the day after the result, to just under $25, meant that the shares are yielding 6.4 per cent. If you are retired and not paying tax, the dividend imputation system means that if you buy at these levels, you’re getting more than 8 per cent in your hand per year. While of course the higher the yield, the better, savvy investors are also aware that the stability in the cash flows and the business are also important considerations when purchasing shares for income. So, when buying for income – look for yield and look for stability in the core business.



• New issues
  Also known as Initial Public Offerings or IPOs, these are why the share market was created in the first place. These events mark the first time that companies make their shares available to the public. Once they’re listed on the share market, of course, any one can buy and sell but what is often lucrative is getting an allocation in the IPO before the shares list. In times past, ordinary mortals found it hard to get access to those new floats unless the promoters were having trouble filling them. That’s changing now, thanks to technology, and the returns in recent times have been very good indeed. In 2015 IPOs returned 24 per cent on average. We reported last week that investors in companies that have used our technology to buy the 25 mainly small companies we floated since they started in October 2013 would have found themselves ahead by significant amounts, particularly if they held on to the shares for a year.
  
  We calculated that if they’d bought the full spread of 25 floats, investors would have been up
  5.1% if they sold on the first day
  9.3% if they sold at the end of the first month
  30.6% if they sold at the end of the first 3 months, and
  86.3% if they sold at the end of the first year.



• Defensive stocks
  These are the shares that don’t go down so much when times are tough because they sell consumer staples. Typically, these types of stocks provide a constant dividend and report stable earnings regardless of the state of the share market as a whole. Also known as non-cyclical stocks, these companies operate businesses that are not highly correlated with the economic cycle such as utilities, food, and (traditionally) oil. You don’t give up going to the supermarket, for instance, even in a recession. Don’t expect dramatic growth or even big dividends from this portfolio segment, but it’s always worth having a few defensive shares. Wesfarmers, which owns Coles, is a prime candidate and it’s worth noticing that the shares have traded between around $36 and $45 each for the last 12 months, making them an interesting prospect for the brave investor ready to take a few risks trading them as they move up and down. The yield comes out somewhere between growth and dividend stocks, at around 4.7 per cent. But again, a retiree would be able to beat that, thanks to the dividend imputation system that in some cases will actually see the holder being sent a refund for some of the tax paid by the company. However, be careful not to overload on defensive stocks, even if you are risk averse: these companies typically provide basic needs and so can outperform during a bust, but will underperform during a boom. All in all, a balanced portfolio is just that – balanced. A healthy mix of value accretive shares, incomegenerating holdings, new listings (IPOs), and non-cyclical stocks are likely to grow your nest egg when times are good and keep it well padded when times are tough.



• Strategy or Stock Picking?
  Finally, an observation on stock-picking. Its fun. As rousing on the wins, as it is deflating on the losses. But, at the end of the day, you are ultimately betting either that the market has mispriced the stock (and the market will come to agree with your opinion of hidden value), or that there will be sectorial rotation and your stock will be on the right-side of that rebalancing. So, are ETF’s the answer? They certainly provide diversification. But, remember that nearly all of the largest, most recognizable ETFs are weighted on market capitalization. So, you are effectively determining your allocations purely on size of company. And, I’ve yet to see evidence of a positive and enduring correlation between company size and performance. So, does it really make sense that size determine what you’re ultimately invested in? As they say, a rising tide lifts all boats, and that’s the beauty of ETF’s for some. Goes up, and choosing an ETF was a smart recommendation. Goes down, and ‘blame the market’. Still, not necessarily that good for investors that are simply focussed on risk-weighted outperformance on their investment. In general, the shares of a company may be transferred from shareholders to other parties by sale or other mechanisms, unless prohibited. Most jurisdictions have established laws and regulations governing such transfers, particularly if the issuer is a publicly traded entity. The desire of stockholders to trade their shares has led to the establishment of stock exchanges, organizations which provide marketplaces for trading shares and other derivatives and financial products. Today, stock traders are usually represented by a stockbroker who buys and sells shares of a wide range of companies on such exchanges. A company may list its shares on an exchange by meeting and maintaining the listing requirements of a particular stock exchange. In the United States, through the intermarket trading system, stocks listed on one exchange can often also be traded on other participating exchanges, including electronic communication networks (ECNs), such as Archipelago or Instinet. Many large non-U.S companies choose to list on a U.S. exchange as well as an exchange in their home country in order to broaden their investor base. These companies must maintain a block of shares at a bank in the US, typically a certain percentage of their capital. On this basis, the holding bank establishes American depositary shares and issues an American depositary receipt (ADR) for each share a trader acquires. Likewise, many large U.S. companies list their shares at foreign exchanges to raise capital abroad. Small companies that do not qualify and cannot meet the listing requirements of the major exchanges may be traded over-the-counter (OTC) by an off-exchange mechanism in which trading occurs directly between parties. The major OTC markets in the United States are the electronic quotation systems OTC Bulletin Board (OTCBB) and OTC Markets Group (formerly known as Pink OTC Markets Inc.) where individual retail investors are also represented by a brokerage firm and the quotation service's requirements for a company to be listed are minimal. Shares of companies in bankruptcy proceedings are usually listed by these quotation services after the stock is delisted from an exchange.

Buying

There are various methods of buying and financing stocks, the most common being through a stockbroker. Brokerage firms, whether they are a full-service or discount broker, arrange the transfer of stock from a seller to a buyer. Most trades are actually done through brokers listed with a stock exchange. There are many different brokerage firms from which to choose, such as full service brokers or discount brokers. The full service brokers usually charge more per trade, but give investment advice or more personal service; the discount brokers offer little or no investment advice but charge less for trades. Another type of broker would be a bank or credit union that may have a deal set up with either a fullservice or discount broker. There are other ways of buying stock besides through a broker. One way is directly from the company itself. If at least one share is owned, most companies will allow the purchase of shares directly from the company through their investor relations departments. However, the initial share of stock in the company will have to be obtained through a regular stock broker. Another way to buy stock in companies is through Direct Public Offerings which are usually sold by the company itself. A direct public offering is an initial public offering in which the stock is purchased directly from the company, usually without the aid of brokers. When it comes to financing a purchase of stocks there are two ways: purchasing stock with money that is currently in the buyer's ownership, or by buying stock on margin. Buying stock on margin means buying stock with money borrowed against the value of stocks in the same account. These stocks, or collateral, guarantee that the buyer can repay the loan; otherwise, the stockbroker has the right to sell the stock (collateral) to repay the borrowed money. He can sell if the share price drops below the margin requirement, at least 50% of the value of the stocks in the account. Buying on margin works the same way as borrowing money to buy a car or a house, using a car or house as collateral. Moreover, borrowing is not free; the broker usually charges 8–10% interest.

Selling

Selling stock is procedurally similar to buying stock. Generally, the investor wants to buy low and sell high, if not in that order (short selling); although a number of reasons may induce an investor to sell at a loss, e.g., to avoid further loss. As with buying a stock, there is a transaction fee for the broker's efforts in arranging the transfer of stock from a seller to a buyer. This fee can be high or low depending on which type of brokerage, full service or discount, handles the transaction. After the transaction has been made, the seller is then entitled to all of the money. An important part of selling is keeping track of the earnings. Importantly, on selling the stock, in jurisdictions that have them, capital gains taxes will have to be paid on the additional proceeds, if any, that are in excess of the cost basis.

Short Selling

Short selling a stock is when an investor borrows stock shares from a lender, and then immediately sells the shares.[24] Then, before a certain time period, the investor buys back stock (called covering). Fundamentally, an investor is betting[24] that the stock will drop. So, an investor makes a profit, when a stock lowers down in short selling.

Risks of Short Selling

Short selling risks are usually more than buying a stock. This is because, theoretically, the loss can be infinite, since the stock can go up in value forever.

Stock price fluctuations

The price of a stock fluctuates fundamentally due to the theory of supply and demand. Like all commodities in the market, the price of a stock is sensitive to demand. However, there are many factors that influence the demand for a particular stock. The fields of fundamental analysis and technical analysis attempt to understand market conditions that lead to price changes, or even predict future price levels. A recent study shows that customer satisfaction, as measured by the American Customer Satisfaction Index (ACSI), is significantly correlated to the market value of a stock.[25] Stock price may be influenced by analysts' business forecast for the company and outlooks for the company's general market segment. Stocks can also fluctuate greatly due to pump and dump scams.

Share price determination

At any given moment, an equity's price is strictly a result of supply and demand. The supply, commonly referred to as the float, is the number of shares offered for sale at any one moment. The demand is the number of shares investors wish to buy at exactly that same time. The price of the stock moves in order to achieve and maintain equilibrium. The product of this instantaneous price and the float at any one time is the market capitalization of the entity offering the equity at that point in time. When prospective buyers outnumber sellers, the price rises. Eventually, sellers attracted to the high selling price enter the market and/or buyers leave, achieving equilibrium between buyers and sellers. When sellers outnumber buyers, the price falls. Eventually buyers enter and/or sellers leave, again achieving equilibrium. Thus, the value of a share of a company at any given moment is determined by all investors voting with their money. If more investors want a stock and are willing to pay more, the price will go up. If more investors are selling a stock and there aren't enough buyers, the price will go down. Note: "For Nasdaq-listed stocks, the price quote includes information on the bid and ask prices for the stock." That does not explain how people decide the maximum price at which they are willing to buy or the minimum at which they are willing to sell. In professional investment circles the efficient market hypothesis (EMH) continues to be popular, although this theory is widely discredited in academic and professional circles. Briefly, EMH says that investing is overall (weighted by the standard deviation) rational; that the price of a stock at any given moment represents a rational evaluation of the known information that might bear on the future value of the company; and that share prices of equities are priced efficiently, which is to say that they represent accurately the expected value of the stock, as best it can be known at a given moment. In other words, prices are the result of discounting expected future cash flows. The EMH model, if true, has at least two interesting consequences. First, because financial risk is presumed to require at least a small premium on expected value, the return on equity can be expected to be slightly greater than that available from non-equity investments: if not, the same rational calculations would lead equity investors to shift to these safer non-equity investments that could be expected to give the same or better return at lower risk. Second, because the price of a share at every given moment is an "efficient" reflection of expected value, then—relative to the curve of expected return—prices will tend to follow a random walk, determined by the emergence of information (randomly) over time. Professional equity investors therefore immerse themselves in the flow of fundamental information, seeking to gain an advantage over their competitors (mainly other professional investors) by more intelligently interpreting the emerging flow of information (news). The EMH model does not seem to give a complete description of the process of equity price determination. For example, stock markets are more volatile than EMH would imply. In recent years it has come to be accepted that the share markets are not perfectly efficient, perhaps especially in emerging markets or other markets that are not dominated by well-informed professional investors. Another theory of share price determination comes from the field of Behavioral Finance. According to Behavioral Finance, humans often make irrational decisions—particularly, related to the buying and selling of securities—based upon fears and misperceptions of outcomes. The irrational trading of securities can often create securities prices which vary from rational, fundamental price valuations. For instance, during the technology bubble of the late 1990s (which was followed by the dot-com bust of 2000–2002), technology companies were often bid beyond any rational fundamental value because of what is commonly known as the "greater fool theory". The "greater fool theory" holds that, because the predominant method of realizing returns in equity is from the sale to another investor, one should select securities that they believe that someone else will value at a higher level at some point in the future, without regard to the basis for that other party's willingness to pay a higher price. Thus, even a rational investor may bank on others' irrationality.

Arbitrage trading

When companies raise capital by offering stock on more than one exchange, the potential exists for discrepancies in the valuation of shares on different exchanges. A keen investor with access to information about such discrepancies may invest in expectation of their eventual convergence, known as arbitrage trading. Electronic trading has resulted in extensive price transparency (efficient-market hypothesis) and these discrepancies, if they exist, are short-lived and quickly equilibrated.

Donating

In certain countries, stock holders can give their shares to charities. United States allows donors to give up to 30% of their adjusted gross income to a 501(c)3 certified charity. The primary benefit of donating stock is that the donor can deduct the market value at time off of their taxable income. In additional, any appreciated gain on the donated stock is waived by the IRS when the charity sells the stock. Twitter CEO saved an estimated $380 million in taxes with his April 2020 gift by completing a stock donation.

HISTORY OF STOCKS

During the Roman Republic, the state contracted (leased) out many of its services to private companies. These government contractors were called publicani, or societas publicanorum as individual companies.[8] These companies were similar to modern corporations, or joint-stock companies more specifically, in a couple of aspects. They issued shares called partes (for large cooperatives) and particulae which were small shares that acted like today's over-the-counter shares. Polybius mentions that "almost every citizen" participated in the government leases. There is also evidence that the price of stocks fluctuated. The Roman orator Cicero speaks of partes illo tempore carissimae, which means "shares that had a very high price at that time". This implies a fluctuation of price and stock market behavior in Rome. Around 1250 in France at Toulouse, 100 shares of the Société des Moulins du Bazacle, or Bazacle Milling Company were traded at a value that depended on the profitability of the mills the society owned. As early as 1288, the Swedish mining and forestry products company Stora has documented a stock transfer, in which the Bishop of Västerås acquired a 12.5% interest in the mine (or more specifically, the mountain in which the copper resource was available, the Great Copper Mountain) in exchange for an estate. The earliest recognized joint-stock company in modern times was the English (later British) East India Company, one of the most notorious joint-stock companies. It was granted an English Royal Charter by Elizabeth I on 31 December 1600, with the intention of favouring trade privileges in India. The Royal Charter effectively gave the newly created Honourable East India Company (HEIC) a 15-year monopoly on all trade in the East Indies. The company transformed from a commercial trading venture to one that virtually ruled India as it acquired auxiliary governmental and military functions, until its dissolution. The East India Company's flag initially had the flag of England, St. George's Cross, in the corner. Soon afterwards, in 1602, the Dutch East India Company issued the first shares that were made tradeable on the Amsterdam Stock Exchange, an invention that enhanced the ability of joint-stock companies to attract capital from investors as they now easily could dispose of their shares. The Dutch East India Company became the first multinational corporation and the first megacorporation. Between 1602 and 1796 it traded 2.5 million tons of cargo with Asia on 4,785 ships and sent a million Europeans to work in Asia, surpassing all other rivals. The innovation of joint ownership made a great deal of Europe's economic growth possible following the Middle Ages. The technique of pooling capital to finance the building of ships, for example, made the Netherlands a maritime superpower. Before the adoption of the joint-stock corporation, an expensive venture such as the building of a merchant ship could be undertaken only by governments or by very wealthy individuals or families. Economic historians[who?] find the Dutch stock market of the 17th century particularly interesting: there is clear documentation of the use of stock futures, stock options, short selling, the use of credit to purchase shares, a speculative bubble that crashed in 1695, and a change in fashion that unfolded and reverted in time with the market (in this case it was headdresses instead of hemlines). Edward Stringham also noted that the uses of practices such as short selling continued to occur during this time despite the government passing laws against it. This is unusual because it shows individual parties fulfilling contracts that were not legally enforceable and where the parties involved could incur a loss. Stringham argues that this shows that contracts can be created and enforced without state sanction or, in this case, in spite of laws to the contrary.