What is a Stock? (in 3 minutes)
A short answer to the most basic question explaining what does it mean to own a stock.
This post is the first in The New Investor series. Let’s go.
Unless you’ve been living in a cave in the Himalayas, chances are that you’ve heard of stocks. Even if you live in a mountain cave, I bet you’ve received a stock tip from a snow leopard.
You have heard of how your uncle lost so much money in the stock market. Maybe seen your dad watching business news to get the latest investment ideas.
I want to kick off The Investment Compass by elaborating on this basic question.
What is a stock?
Let me first explain what a stock and the stock market is NOT.
A Stock is not a price that moves up and down
It is not a number attached to a piece of paper
The stock market is not a place to get rich quickly
The stock market is not some elusive place for rich people in suits
With that out of the picture, let us come to the meaning of stock.
What does it mean to own stock?
A stock represents a share in a real-world business. Owning a stock is the same thing as owning a business. It entitles you to receive the profits of the business, bear the losses of the business, pay the creditors, own the inventory, etc.
I repeat a stock represents a share in a real-world company. Guess what stocks are also called? Shares.
Let’s say you own 100 shares of Reliance Industries. This makes you a partial owner along with the Ambani family in their business (cool, isn’t it?).
Why do the Ambanis want you to own Reliance Industries?
At some point during the journey of Reliance, its owners decided that they needed funds to expand their business. They wanted to set up additional factories, expand into various industries, or maybe pay the loan they had taken from the bank.
In short, they needed money.
Dhirubhai Ambani decided to sell a part of his company to the general public by dividing it into multiple shares. Those shares are still available to buy/sell. People trade them among themselves in the stock market.
Own them and you own a part of Reliance!
Now we come to the next logical question.
Why do stock prices move up and down?
As you now know a stock is nothing but a share of a business. Its price is impacted by how well the business is expected to do in the future. The important thing to remember here is
If the business does well, the stock price will eventually follow and if the business takes a turn for the worse, the stock price will come down.
The stock price is a slave to the earnings of a business.
This is the most basic thing to remember about stocks.
Remembering this fact will serve you well both in euphoric times and in distress.
There is a psychological factor also behind the movement of stock prices but we will get into that later.
Up next: What can stocks do?
I have started The Investment Compass to make it a place where you can go from a beginner to an informed investor. This is a journey where I will attempt to foster a community that interacts and grows together.
The Investment Compass will:-
Take you from a beginner to an advanced investor in The New Investor series
Keep you updated on companies and their businesses
Deep Dive into company fundamentals and their valuation
Discuss and review books on investment, behavioral psychology, finance, and philosophy
The Investment Compass is completely free to read.
Recommend us to a friend!