A stock is a fractional ownership interest in an underlying business.
What is the purpose of a stock?
Oftentimes, companies need to raise cash for various business operations like buying new machines, building a factory, or developing new products. One of the ways companies can raise cash is by selling stock or ownership in its business. This means that company ownership is exchanged for cash.
The company sells stock, it receives cash
The buyer of stock receives ownership in the company.
Typically, companies will sell many shares of stock, each representing a fractional ownership interest in the business. For example, a company can sell 1,000,000 shares of stock that represents 20% of its business. Each share of stock represents a small fraction of ownership, but if you add up all the shares, they make up 20% in this example.
And typically, there will be many buyers, not just one. The reason for this is that a company’s cash needs can be quite large. We are talking in the millions or billions of dollars to fund business operations. It is easier to raise a large amount of money across many buyers than it is to find only one buyer that has enough money to fulfill the cash need.
Let’s look at an example.
Company XYZ needs $10 million dollars to build a new manufacturing plant. To raise this cash, the company decides to sell 20% of its business by selling stock. The company issues 1,000,000 shares of stock to represent 20% ownership of the company. When the company is able to find buyers for its stock, either publically or privately, the process is complete.
As a result, the company gets the cash it needs and the buyers of the stock will each become fractional owners in the company. As a group, the buyers now represent 20% ownership of the company.
Why do people buy stocks?
When you buy the stock of a company, you become a part owner of that company. As an owner, you are entitled to the company’s assets and profits. If the company grows and becomes profitable, the value of your stock also grows.
People buy stocks for their price appreciation or for dividend income. So they seek to buy stocks of companies they believe will have future growth and profits. Buying the stock of a company is considered an investment.
Where can you buy stocks?
You can buy stocks in the stock market. A broker can give you access to buy and sell stocks in the market.