What are stocks anyways?

I know I have been babbling things about investing in stocks and yet I haven’t explained yet what are stocks. So I am writing these to share you something about stocks….. I’ll make the story as short as possible 🙂

There are 3 basic forms of business organization. These business models or layout are primarily based on the ownership of a person or persons involved has on the business. These are Sole Proprietorship, Partnership, and Corporation.

Since our area of concern is about stocks I will just make a short explanation about Sole Proprietorship and Partnership for comparison purposes.

Sole proprietorship, the name says it all. It is a business owned or under the name of one person. It is like a “tindahan” with the name “Tindahan ni ALlng Nena”. The business may be owned or maybe run by the family of Aling Nena but as regards to recognition the business is under Aling Nena’s name thus she is the Sole owner.

Partnership in Philippine law is formed when 2 or more persons enter into an agreement to join and form a business and share earnings and losses.Also under Philippine law when partners agree to join and form such to operate a business a juridical person is created thus the partnership stands as one juridical person in the eyes of the law under the Partnership Code of the Philippines and the partners represent the partnership.When one or some of the partners die, withdraw, or sell his interest in the partnership, the partnership is dissolve and the remaining partners has the option to continue the partnership by agreeing to new agreement or to totally dissolve the partnership.(If this one seems nosebleed to you better ask your lawyer or CPA friend to further expound about this topic I hope they don’t charge you consultation fee).

And now about the topic I should have discuss in the beginning.

Here is the definition of a corporation from the Philippines Corporation Code or Batas Pambansa Blg. 68:

Sec. 2. Corporation defined. – A corporation is an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence.(taken from http://www.chanrobles.com/legal5title1.htm#TITLE%20I)

Corporation is business model where at least 5 but not more than 14 incorporators, which must be natural persons, form the corporation requiring at least that 25% of the authorized shares is subscribed and that 25% of the subscribed shares are paid. From there on ownership of the company can be transferred from one person to another through sale, inheritance, or donation and the remaining unsubscribed shares can be issued to interested investors or through a stock market by way of an Initial Pubic Offering(IPO).

Stocks or Shares of stocks represent one’s ownership in the stock-corporation in particular because there are corporations which are non-stock corporation(again ask your lawyer or CPA friend to explain these further). As stated in the definition corporations has the “right of succession” meaning stock ownership can be transferred from one person to another. In law person can be natural person or juridical person(again ask your lawyer or CPA friend about this).

A corporation’s stock could either be a common stock(share capital) or a preferred stock(preference share). To defined common stock let us first define preferred stock which is defined as stocks that carry no voting rights(with some special cases where such stocks can vote), but may carry priority over common stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend  that is paid out prior to any dividends being paid to common stock holders. Preferred stock may have a convertibility feature into common stock.  

Common stock is the opposite of Preferred stock. Preferred stock may have a stated rate of dividend that must be paid out first before paying out Common stock holders and will be given priority on the return of capital in case of liquidation. In a way it has the qualities of a loan or bond because of the attached rate that the company must pay out first to each Preferred stock holder before paying some to common stock holders.

The good thing with this is that a Preferred stock share in the company’s earnings is limited to the rate stated, so when the company has performed well the remaining distributable earnings all goes to the common stock holders after satisfying the amount due to preferred shares holder.

The proceeds of the initial sale of the stock from the company goes to the equity section of the company where we based the Book value per share. A stock may have a par value but could be bought at above par thus when you read a company’s Balance sheet a portion of the Stockholder’s Equity has the section Paid in Capital. This represent the amount paid by the investor on top of the par value. In the company’s book it is not recorded as income because such transaction is related to financing activity rather than its operating activity.

When the initial investor sales his or her stocks to another person the proceeds now goes to the investor since it is mere sale of his or her property to another which may be at a profit or at a loss. Thus stock market are there for such transactions. Stock markets has rules to follow to make sure the transfer of stocks from one person to another is properly recorded and that the investing public interest’s is safeguarded against fraud. 

Though the stock’s market price is not dictated by the company that issued it, investors still look into the operation of the company to gauge its value and demand a higher price in times that the company performs well. Thus a company that reported a good performance will have its traded shares having a higher market price because investors sees that as a value added to the stock which one can get when such is a holder of it. These is what we call dividend. But since such could still be sold in a stock market one would normally sell to gain profit from there investment.