What is a stock, and how do you make (or lose) money with it?
What owning a share actually means, the two ways it can pay you — dividends and a higher price — and the risks that come with it.
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A stock (or share) is a small piece of ownership in a company. If a company is split into 100 million shares and you own 100, you own one millionth of it: of its factories, its brands, its cash and its debts, and of the profit it makes from now on.
Why companies issue shares
Companies sell shares to raise money without borrowing it. The first sale to the public is the IPO (initial public offering); after that, the shares change hands between investors on a stock exchange. When you buy a share today, you almost always buy it from another investor, not from the company.
The two ways a share pays you
1. Dividends
Some companies pay out part of their profit to shareholders in cash, usually once, twice or four times a year. If a company pays €2 per share a year and the share costs €50, its dividend yield is 4%. Dividends are not guaranteed: the company decides each year, and it can cut or cancel them.
2. A higher price
If the company grows its profit, investors tend to pay more for each share over time. Selling for more than you paid is a capital gain. Buy at €50, sell at €70, and you made €20 per share before costs and taxes.
Over the long run, a share price tends to follow the company’s profit. In the short run it can move for many other reasons: interest rates, news, fear or enthusiasm.
What moves the price
A share’s price is simply what the last buyer and seller agreed on. It rises when more people want to buy than to sell at the current price, and falls when the opposite happens. Behind those decisions are expectations: how much the company will earn in the future, and how much investors are willing to pay for each euro of those earnings — which is what the P/E ratio measures.
The risks
- The company can do badly. Lower profit usually means a lower price, and the dividend may be cut.
- The company can fail. Shareholders are paid last, after lenders and suppliers, so in a bankruptcy they often get nothing.
- Prices can fall for a long time. Even good companies can trade below what you paid for years.
- Concentration. Putting all your money in one or two companies makes each of these risks larger. Spreading it over many businesses, diversifying, reduces the damage any one of them can do.
Stock, share, equity
You will see the three words used almost interchangeably. Stock and equity often refer to ownership in general; a share is one unit of it. In practice, “I bought 10 shares of X” and “I own X stock” mean the same thing.
Where to go next
Once you know what a share is, the next step is learning to read the company behind it: start with how to read a balance sheet, and with the P/E ratio to see what the market is paying for its profit.
