Investor Education

Starting at the Beginning: What is a stock?

So, I realized that I might’ve made a mistake just jumping into this blog, a blog which I intended to be for beginners in the world of stock investing and given an analysis which was both too hard to understand and incompetent in its analysis of the company and I apologize. With this post, I hope to rectify my mistake and to start at the very beginning of teaching what I know of stock investing.

-Mohit D. Patel

Anyhow, to start off we must answer a rudimentary question: what is a stock? Now many people will say many things about what stocks and stockholders are, and that is natural seeing as finance and politics are nearly inseparable. In order for me to best explain this I have to explain the three main forms of ownership for a business; they are proprietorship, partnership, and corporation. It perfectly alright if you have no idea what these terms are, I’ll explain all of ’em; on the other other hand if you do already know, you’re ahead of the game.

A proprietorship is when an individual person for legal purposes is considered to be the business. In order to form this type of business, a person does not have to file any forms with the government, all they have to do start doing business. In the case of a business like this the person who starts the business reports all of the money that they make on their own tax form. This type of tax form is called a form 1040. If a proprietorship business owes money or has a lawsuit filed against it the owner, who started the business must answer to the suit or pay back the loan and the government will seize their personal property if it has to in order to pay off the debt or settle the law suit. The fact that the government can do this is what a lawyer would call unlimited liability. Additionally while one person is considered to own and be the business, they can hire employees to work for them and then they would pay them a salary.

The second form of ownership is a partnership. This form of business is very similar to a proprietorship except that instead of one owner legally being the business, there are two or more persons who own the business. The laws apply the exact same way and the unlimited liability concept described above extends to all of the partners. One of the few differences between a partnership and a proprietorship is that a partnership formed by a group of people signing a contract called a partnership agreement which outlines how the partnership will function. Normally a partnership will dissolved if any of the partners die, file bankruptcy, or leave the business unless the agreement says other wise. In order for a person to be allowed to invest in this type of business they must be made a partner which would require the partnership agreement to be amended and for the investor to take on all of the risks of being a partner including having to pay back to the partnership’s debts and taking on any law suit that may be filed. For this reason many large businesses find this structure of ownership to be too burdensome and opt to choose the next structure instead.

The next form of business ownership is the one that is of utmost importance to a potential stock investor. It is a corporation. Many people talk a bout corporations without actually know what they are. Corporations inherently have very little to do with business, instead they are a purely legal construct. A corporation is created by filing a form with any state government, called a certificate of incorporation or sometimes articles or incorporation and receiving approval. Once a corporation has been successfully been created, in the eyes of the law it is its own person. A corporation can file law suits, have suits against it, it must pay taxes, and it can enter into contracts. Within the legal structure of a corporation there are two groups of people: directors and shareholders. When a corporation is created it is given the right to issue a certain number of shares of equity. In accounting the word equity means ownership of the business. Once the shares are issued the holders of the shares are owners of the company. A corporation unlike a partnership unlike a proprietorship or partnership has what in the field of law is called limited liability. What this means is that the shareholders cannot be sued directly for an action taken by the corporation, and they cannot be forced to pay the debts of the corporation. This is the opposite of unlimited liability and you guessed it; it’s called limited liability. The group of people we mentioned are the directors. The directors are responsible for the day to day running of the company on behalf of the shareholder. The directors are what are called agents of the of the shareholders. This means that legally they must do whatever they believe would most benefit the shareholders of the corporation. In most large business corporations, the directors don’t all actually manage the business, instead they hire a group management officials to do. The titles of these officials are those that most people used to hearing when they talk about big businesses i.e. President, Exeutive VP, Chief Executive Officer, Chief Marketing Officer, Chief Counsel, etc. It should be noted that in each corporation the specific roles of both directors and shareholders are spelled out in a document called the corporation’s bylaws, which like the partnership agreement in a partnership explains how the corporation is to be run and governed.

So, if you’ve actually read this far you be wondering, when is he actually going to tell me what a ‘stock’ is. I’ll get to that right now. A stock is a share of corporation’s equity as we mentioned before that is easily traded by people through broker/dealer firms and/or one or more clearing houses. There are many requirements that have to be met for a corporation to trade its shares publicly as stock. The individual requirements depend on what brokerage or clearing house, the corporation wants to be listed on. The New York Stock Exchange has the most strict requirements, OTC Pink, which used to be known as the Pink Sheets very little requirements to be listed.

This article is provided on an as is basis and is not meant to constitute legal or finance advice. The author is a student, not an attorney or finance professional.

If you have any questions please leave them in comment section below!