What are stocks?

Why Companies Issue Stocks?

It will decide to “go public” for four reasons.

First, it may wish to expand and needs the massive amount of capital received in an IPO (initial public offering).

Second, many companies offer stock options to their early employees as an incentive to come on board. That’s because many start-ups don’t have the cash flow to pay highly skilled executives. The promise that they will make millions once the company goes public can be enough to bring them on board.

Third, the founders may wish to cash in on their years of hard work. They award themselves large amounts of stock in an IPO, which is typically worth millions of dollars. They are prohibited from selling it right away. They rarely sell all their stocks at once, since this would be interpreted as a loss of confidence in the company. Instead, they sell it gradually over time.

A fourth reason a company goes public is to allow the owners to diversify their financial portfolio. It is risky for them to have all their personal finances tied up with their companies.

Why IPO?

The simple answer to this is that the company, by offering its shares makes you a partner and shares the risk of running the business with you. If they were to borrow the money from the bank, they need to ensure they return the funds in the defined time interval and also pay the interest. This may not always work out to be the best option.

Types of Stocks

There are a number of different kinds of stocks, and their classifications largely depend on the rights they confer on the holder. Investors evaluate these categories based on their investment objectives and they look for stocks that meet those objectives.

Common Stock and Preferred Stock

The most prominent characteristic of common stock is that it entitles the shareholder to vote on corporate matters (typically, the shareholder gets one vote for every share he or she owns, though that is not always the case) such as whether the company should acquire another company, who the board members should be and other big decisions. Common stock also often comes with preemptive rights, which means the shareholder has a “right of first refusal,” or first dibs on buying any new stock the company tries to issue.

Perhaps the most important attribute of common stock is that holders are the last in line when it comes to getting their money back. If the company goes bankrupt and has to sell off all its assets, the cash from the asset sale first goes to pay off lenders, employees and lawyers. The shareholders get whatever is left (which is usually nothing, or just a few pennies for every dollar they originally invested).

This pecking order is why preferred stock, the other popular category of stock, exists. Although preferred stock owners don’t usually get any voting rights, they usually receive a steady dividend and their claim to the company’s assets “outrank” the common stockholders’ claims (i.e., in the event of bankruptcy, the company must pay off lenders, preferred shareholders, employees and lawyers before the common shareholders get anything).1

The nature of a company’s business also determines many of the characteristics of its stock.

Some stocks move in accordance with the economic cycle, and some move in the opposite direction. Knowing which stocks are which can help you decide when to buy and sell some of your holdings. Cyclical stocks, for example, increase in value when the economy is growing and decrease in value when the economy is shrinking.

Briefly, here are some other categories of stock that investors look at:
1. Growth stocks: Shares of fast-growing, higher-risk companies. They offer a higher chance of higher returns and a higher chance of bankruptcy.
2. Tech stocks: Shares of technology companies. Like growth stocks, they are generally riskier than other types of companies, but they also offer a chance at very high returns.
3. Small-cap, mid-cap and large-cap stocks: Stocks from small, mid-size and large companies. The “cap” is short for capitalization, which is simply the number of shares outstanding times the current price per share. It’s important to note that a company’s stock can fall into more than one category. Large-cap stocks can be blue-chip stocks, growth stocks or income stocks, for example. Small-cap stocks can be growth stocks, income stocks or tech stocks.

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