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Another common question I get a lot is, what is a stock? When I ask this question back, they seem to have heard of it but they can’t bring themselves to explain.
A stock is written piece of proof that represents ownership of a company. I don’t mean business registration and other similar papers, which are all documents that legally declare its identity. Rather, it describes the portion of ownership of a company by an investor.
Let me break that down.
In a sole proprietorship where only person owns the business, we can say that the company has only one stock that belongs entirely to the business-owner. As it grows, its need for capital increases. Capital is the money that is used for setting up, operating and expanding a business.
Splitting the stock
And let’s say that instead of borrowing from the bank, the entrepreneur invites people to become partners. The company can then decide to become a corporation.
When it becomes a corporation, then we can say that the company’s stock is split between the owners. Each will have a share, and each will have fractional ownership of the company, now called equity.
There is a difference between stocks, shares, and equities.
There are two ways to raise capital:
- Debt. The entrepreneur can take on debt by borrowing money from people or banks. S/He will need to pay back with interest within a period of time.
- Stockholders. Or, the entrepreneur can invite people to join the business venture. Each one of the new business partners will need to put up a capital, and in return will own a portion of the company that is proportionate to the contribution. And all of them will enjoy whatever gains the business earns.
A common stock is one we are all familiar with. It is traded in the market-place called Philippine Stocks Exchange.
The benefits of buying and owning a common stock are many. For one, you are a part-owner of the company and you are entitled to either its gains or loss. You are also given the right to attend a stockholder’s meeting and the right to vote.
A preferred stock is rather interesting. It is usually not offered in the market. It is the same as the common stock in the way that it represents your ownership of a company.
Its difference is, owners of preferred stock get dividends ahead of everyone else. A dividend is a portion of profit that a company earns that is given back to the stockholders. The people who hold common stocks are given next.
Another difference is that owners of preferred stocks are also entitled to get their share first should the company sells all of its assets and closes its entire business.
But the last difference, it does not have any voting rights.
How are stocks traded in Philippine Stocks Exchange?
Companies can let their stocks be made available to everyone through a process called initial public offering (IPO). An IPO is the first day that a company releases its stocks to the stock market, the Philippine Stocks Exchange. And any interested buyer can purchase them.
Before an IPO can happen however, a company has to go through a lot of steps with the Securities and Exchange Commission.
Should you buy common or preferred stock?
If you are an investor, you might be thinking of having preference of one over the other. Majority of us however are most likely able to buy common stocks.
A preferred stock is actually good for people who want to have regular income through the dividend. You can actually consider it as a fixed income, as it provides pay-out periodically.