Chapter 2: Stocks Explained


In the first chapter we learned about what markets were, and specifically talked about the stock market. You might still be wondering though what is stock? As we talked about in the Apple example, stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earning. While you can’t buy the whole stock at once technically speaking, you can buy SHARES of stock that are issued by the company. In chapter one, we bought one share of Apple’s stock for $500 and earned $50 profit when the stock moved upward to $550. When you own a share of stock, you are a part owner in the company with a claim (however small it may be) on every asset and every penny in earnings. Let’s go over another example in which YOU are a company selling stock to the public. Imagine you wanted to start a retail store with members of your family. You decide you need $100,000 to get the business off the ground so you incorporate a new company. You divide the company into 1,000 pieces, or “shares” of stock. (They are called this because each piece of stock is entitled to a proportional share of the profit or loss). You price each new share of stock at $100. If you can sell all of the shares to your family members, you should have the $100,000 you need (1,000 shares x $100 contributed capital per share = $100,000 cash raised for the company). If the store earned $50,000 after taxes during its first year, each share of stock would be entitled to 1/1,000th of the profit. You’d take $50,000 and divide it by 1,000, resulting in $50.00 earnings per share (or EPS as it is often called on Wall Street). Although there are many more steps a company will take when deciding what to do with money that it earns, let’s just leave our example as it is so we can just get a basic understanding of stock.

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