Explanation of How Stock Shares Work

Stock represents ownership in a company. When you buy a share of stock, you become a partial owner of the company that issued the stock. However, the details of your ownership rights may depend on both the issuing company and the type of stock you own.

Stock Offerings

A company offers stock for purchase in order to raise cash from the sale. A stock offering may be public, in which case anyone can buy the stock on an open exchange; or it can be private, meaning that the stock is offered to only selected investors. Unlike a purchase of bonds, which are debt that the company must eventually repay, a purchase of stock carries no guarantee of repayment for the purchaser. When you buy stock in a company, you effectively make a bet on the company's performance. There's no guarantee that you will receive a return on your investment.

Dividends

Shareholders typically have the right to receive dividends, a proportional share of the company's profits. However, dividend rights may depend on whether a shareholder holds "common" or "preferred" stock. Preferred shareholders have the right to get paid their dividends before the common stock shareholders do. This order of precedence can become important if a company's profits for a given year are insufficient to pay dividends to all of its shareholders. If the company has a particularly bad year, the board of directors may decide not to declare dividends at all; in this case, none of the shareholders get paid. However, some classes of preferred stock do accumulate the right to be paid back dividends owed from prior years.

Ownership Rights

A person who buys stock in a company becomes a partial owner. In the case of common stock, this ownership includes the right to vote on the members of the company's board of directors. However, how much this ownership is worth depends on how many outstanding shares of stock the company has (meaning, how many shares the company has sold). For instance, if you own 100 shares of Company A, and Company A only has 1,000 shares of stock outstanding, your ownership and voting rights are significant. But if you own 100 shares of Company B, and Company B has well over 1 million shares in the open market, your ownership rights may become negligible. Preferred shares typically don't carry voting rights unless the board fails to declare dividends for an extended period of time.

Restrictions on Sale

Typically, if you own publicly traded stock, you're free to sell it as you please. However, some stock shares carry restrictions on the owner's ability to transfer. For instance, some companies may offer a good price at an initial offering in return for the new shareholder's promise not to sell the stock for a certain period of time. Stock shares offered to employees in lieu of compensation will also usually carry restrictions on when the employee may sell. Any special rules for selling a particular stock will generally be available on the stock certificate.