Stocks: Sharing a Corporation

Stocks are pieces of the corporate pie. When you buy stocks, or shares, you own a slice of the company.

Stocks are equity investments. If you buy stock in a corporation, you have an ownership share in that corporation and are described as a stockholder or shareholder. You buy stock because you expect it to increase in value, or because you expect the corporation to pay you dividend income, or a portion of its profits. In fact, many stocks provide the potential for both growth and income.

When a corporation issues stock, it gets the proceeds from that initial sale. After that, shares of the stock are traded, or bought and sold among investors, but the corporation gets no additional income. The price of the stock moves up or down depending on how much you and other investors are willing to pay for it at the time.

Common Stock
Most stock in the U.S. is common stock. Owning common stock entitles you to collect dividends if the corporation pays them, to sell your stock at a profit if its price increases, and to vote for the board of directors. Common stock prices aren’t fixed, so they can lose value as well as gain it. And some stocks are volatile, which means their prices may increase or decrease rapidly.

Despite these risks, investors are willing to buy common stock because over time stocks in general – though not every individual stock – have provided a stronger return than other investments.

Blue chip is a term borrowed from poker, where the blue chips are the most valuable. Blue chip stocks are those of the largest, most consistently profitable corporations. The list isn’t official – and it does change.

Preferred Stock
Some corporations issue preferred stocks in addition to common stocks. These stocks are listed on a stock market and traded among investors, just as common stocks are. Preferred stock dividends are often guaranteed by the corporation, unlike dividends on common stock, and the stock prices tend to be more stable, changing very little over time. What’s more, preferred shareholders may recover some of their investment if the company fails (prior to common stock shareholders). These factors help explain why preferred stock is sometimes described as a hybrid fixed-income and equity investment.

Classes of Stock
Companies may issue different classes of stock, label them differently, and list them separately on a stock market. Sometimes a class indicates ownership in a specific division or subsidiary of the company. Other times it indicates shares that sell at different market prices, have different dividend policies, or impose voting or sales restrictions on ownership.

Stock Splits
When the price of a stock increases significantly, you and other investors may be reluctant to buy, either because you think the price has reached its peak or because it costs so much.

Corporations have the option of splitting the stock to lower the price, which they expect to stimulate trading. When a stock is split, there are more shares available, but the total market value is the same. For example, say a company’s stock is trading at $100 a share. If the company declares a two-for-one split, it gives you two shares for each one you own. At the same time the price drops to $50 a share. If you owned 300 shares selling at $100 you now have 600 selling at $50 – but the value of your holding is still $30,000.

The initial effect of a stock split is no different from getting change for a dollar. But in a strong market the price may move up toward or even beyond the presplit price, increasing the value of your stock portfolio. Stocks can split three for one, three for two, ten for one or any other combination.

Reverse Splits
In a reverse split the corporation exchanges more shares for fewer – say ten shares for five – and the price per share increases accordingly. The motive may be to boost the price so that it meets a stock market’s minimum listing requirement or makes the stock attractive to institutional investors, including mutual funds and pension funds, which may not buy very low-priced stocks.

Common Stock Preferred Stock Split Stock
Owners share in success when company profits Dividend payment has priority over common stock dividends More shares created at lower price per share
Owners at risk if company falters Dividends don't increase if company prospers
Stock value increases as price goes up toward or beyond presplit levels
© 2004 by Lightbulb Press, Inc. All Rights Reserved.
This information is provided by Lightbulb Press, Inc. and does not express the views of Wells Fargo or any of its affiliates. Wells Fargo is not responsible for the accuracy, completeness, or correctness of the information provided by Lightbulb Press, Inc. or other third parties.

This information is provided with the understanding that the authors and publishers are not engaged in rendering financial, accounting or legal advice, and they assume no legal responsibility for the completeness or accuracy of the contents. Some charts and graphs have been edited for illustrative purposes. The text is based on information available at time of publication. Readers should consult a financial professional about their own situation before acting on any information. Lightbulb Press, Inc., 112 Madison Avenue, New York, New York, 10016, Tel: 212-485-8800, www.lightbulbpress.com.

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