What is a Stock?

Jun 2, 2022 | Getting Started, Investing, Saving & Investing

We have all visited the golden arches of McDonald’s at some point in our lives. While waiting for your fries and Coke, have you ever thought, “I wish I owned McDonald’s?” The good news is you can own a piece of McDonald’s Corporation since it is a publicly traded company that anyone can purchase, but it wasn’t always that way. In 1940 brothers Maurice and Richard McDonald opened McDonald’s Bar-B-Q restaurant in San Bernadino, California and converted it to a self-service drive-in restaurant in 1948 serving hamburgers, cheeseburgers, soft drinks, milk, coffee, potato chips and slices of pie. In April of 1965 the growing restaurant chain decided to take the company public to raise money to expand the business, allowing anyone to invest and become a shareholder. An initial $100 investment in McDonald’s stock in 1965 would be worth $820,285 today, an 8201% return.  Looking in the rearview mirror is always easy to do but this definitely would have been a fantastic investment.  

Before we start looking for the “next McDonald’s” to invest in, let’s take a step back and discuss key considerations Involved with investing in stocks.

What is a stock?

A stock represents partial ownership of a company in the form of an investment, also known as equity. Generally, it gives you the ability to vote on certain aspects of the company as well.  By owning shares of stock, it allows you to participate in the gain or loss of the company along with receiving dividends paid out to the shareholders.  Clearly, this is just a high-level overview so let’s take a deeper look.  

Are there different types of stock?

When most investors are talking about stocks, they are referring to common stocks, but there are actually two types of stock: common and preferred. Each of these have different features and benefits. Common stocks provide voting rights to shareholders while preferred stocks do not. However, preferred stocks take precedent over common stocks when it comes to a stock’s dividend, as shareholders of preferred stock are paid dividends before common shareholders. In the event a company were to file bankruptcy or liquidate, preferred stock shareholders would be paid back before common stock shareholders.  Clearly preferred stocks have some safety benefits that common stocks do not but like most things in life there is a tradeoff.  Common stocks allow you to participate in the long-term growth (or potential loss) of a company.  There are pros and cons to owning each type of stock.  Which one should you own? Let’s keep learning more to help answer that question.  

Why do companies issue stock?

Companies issue stock primarily to raise cash to expand their business and invest in new projects. When companies issue stock (or equity), it can be either privately held or publicly traded on a stock exchange.  Let’s look at two familiar names to make this more familiar. McDonald’s is a publicly traded corporation, and anyone can become a shareholder. Publix grocery store, on the other hand, is a privately held employee-owned company, which means only Publix employees can acquire their stock.

Let’s revisit McDonald’s decision to raise money to expand its business in 1965. The company could have borrowed money from the bank or investors and paid interest, referred to as debt. Instead, McDonald’s offered equity to shareholders in the form of stock. Shareholders who purchased stock in McDonald’s had the potential to participate in the growth and success of the restaurant chain.  At the same time, if the restaurant were not profitable, it’s possible the value of the stock could have decreased or even become worthless.  Unlike a loan or debt, if the restaurant was not profitable, McDonald’s would not have been required to pay back any part of the shareholders’ original investment. The shareholder is an owner of the company, not a creditor.

What does it mean to own common stock and why would you own it?

To own common stock means you have equity, or ownership, in a company.  You might participate in both the profits and losses of the company through earnings and dividends. Depending upon the size of the company you could be one of just a few shareholders, or in the case of a publicly traded stock, one of millions.

When you purchase stock in a company, you do so with the belief that the value of your investment will increase as the company grows and succeeds. The value of your stock might increase for a variety of factors. A company’s share price often increases with growth in earnings and dividends. It can also increase based on supply and demand.  Much like the housing market, if there are more buyers of the stock than sellers, shares of the company stock usually increase in price. 

Stocks offer the potential for growth in an investment portfolio. Why would you want your money to grow? Let’s say for example you have $5,000 in a bank account earning 1% each year.  Because of inflation (the increase in the cost of goods and services), $5,000 today will not buy the same goods and services in the future. Each year, the value of money decreases because it is not keeping up with inflation. Since inflation erodes buying power, many investors choose investments such as stocks with a growth orientation with the goal of outperforming inflation over time.  Historically over the last 50 years, the Standard & Poor’s 500 Index, which is one of the benchmarks used to measure the U.S. stock market, has returned an average of 9.4% per year, clearly outperforming inflation which averaged 3.8%. Stocks clearly sound like a great investment, but it is important to understand that the amount of stock you own in a portfolio compared to other asset classes (such as bonds and real estate) should be driven by your unique goals, time horizon and tolerance for risk.

What is the history of stocks?

The first known publicly traded stock dates all the way back to 1611 in Amsterdam when the Dutch East India Company issued stock to raise cash and finance global exploration. The first stock market in the United States was formed around 1790 as the Philadelphia Stock Exchange. A more recent innovation was in 1896 when Charles Dow created the Dow Jones Industrial Average (the Dow). The index originally tracked 12 stocks, but today it tracks 30 with the assumption that this measurement represents the broad-based market. The value of the stocks comprising the Dow when first created was just 40.94, but today the Dow is nearly 32,000 points- staggering! These days, many stocks are not actually owned through direct ownership but rather through pooled investments such as mutual funds or exchange traded funds (ETF’s).   

Stocks have historically provided fantastic growth as investments, but it is important to understand the risk that comes with investing in stocks.  Proper diversification should be part of your overall portfolio. Investing in stocks in a proper and effective manner requires a great deal of diligence using advanced research strategies.  Should you be investing in stocks?  If so, how much should you invest in stocks?  Again, this is based upon your personal goals, time horizon and tolerance for risk.  If you or someone you know would like to learn more and discuss investment strategies related to stocks, please reach out to our expert Wealth Advisors at GreenUp Wealth Management. 

Author

  • Brad Tatar

    Senior Vice President | Wealth Advisor | Tampa, FL -- For over 15 years, Brad has specialized in working with clients who are in or nearing retirement by taking a holistic view and developing and implementing plans to reach their goals and objectives. Prior to joining GreenUp Wealth Management, Brad served as a managing director for a registered investment advisor as well as having worked for some of the country’s largest broker-dealers. Brad began his career in financial services with Scottrade, Inc. in 2006, where he learned the importance of understanding a client’s needs and developed a passion for providing complex guidance and financial planning. As a Certified Financial Planning candidate, Brad’s expertise is working with clients to review their retirement, insurance, tax, and estate planning needs and creating an investment strategy that aligns with their unique goals. For over 15 years, Brad has specialized in working with clients who are in or nearing retirement by taking a holistic view and developing and implementing plans to reach their goals and objectives.

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