Shares are units of equity ownership in a corporation. For some companies, shares exist as a financial asset providing for an equal distribution of any residual profits, if any are declared, in the form of dividends. Shareholders of a stock that pays no dividends do not participate in a distribution of profits. Instead, they anticipate participating in the growth of the stock price as company profits increase.
Shares represent equity stock in a firm, with the two main types of shares being common shares and preferred shares. As a result, “shares” and “stock” are commonly used interchangeably.
When establishing a corporation, owners may choose to issue common stock or preferred shares to investors. Companies issue equity shares to investors in return for capital, which is used to grow and operate the firm.
Unlike debt capital, obtained through a loan or bond issue, equity has no legal mandate to be repaid to investors, and shares, while they may pay dividends as a distribution of profits, do not pay interest. Nearly all companies, from small partnerships or LLCs to multinational corporations, issue shares of some kind.
Shares of privately held companies or partnerships are owned by the founders or partners. As small companies grow, shares are sold to outside investors in the primary market. These may include friends or family, and then angel or venture capital (VC) investors. If the company continues to grow, it may seek to raise additional equity capital by selling shares to the public via an initial public offering (IPO). After an IPO, a company’s shares are said to be publicly traded and become listed on a stock exchange.
Most companies issue common shares. These provide shareholders with a residual claim on the company and its profits, providing potential investment growth through both capital gains and dividends. Common shares also come with voting rights, giving shareholders more control over the business.
These rights allow shareholders of record in a company to vote on certain corporate actions, elect members to the board of directors, and approve issuing new securities or payment of dividends. In addition, certain common stock comes with pre-emptive rights, ensuring that shareholders may buy new shares and retain their percentage of ownership when the corporation issues new stock.
In comparison, preferred shares typically do not offer much market appreciation in value or voting rights in the corporation. However, this type of stock typically has set payment criteria, a dividend that is paid out regularly, making the stock less risky than common stock. Because preferred stock takes priority over common stock if the business files for bankruptcy and is forced to repay its lenders, preferred shareholders receive payment before common shareholders but after bondholders. Because preferred shareholders have priority in repayment upon bankruptcy, they are less risky than common shares.
Authorized shares comprise the number of shares a company’s board of directors may issue. Issued shares comprise the number of shares that are given to shareholders and counted for purposes of ownership.
Because shareholders’ ownership is affected by the number of authorized shares, shareholders may limit that number as they see appropriate. When shareholders want to increase the number of authorized shares, they conduct a meeting to discuss the issue and establish an agreement. When shareholders agree to increase the number of authorized shares, a formal request is made to the state through filing articles of amendment.
Most stocks are traded on physical or virtual exchanges. The New York Stock Exchange (NYSE), for example, is a physical exchange where some trades are placed manually on a trading floor—yet, other trading activity is conducted electronically.
NASDAQ, on the other hand, is a fully electronic exchange where all trading activity occurs over an extensive computer network, matching investors from around the world with each other in the blink of an eye.
Investors and traders submit orders to buy and sell shares, either through a broker.
A buyer bids to purchase shares at a specified price (or at the best available price) and a seller asks to sell the stock at a specified price (or at the best available price). When a bid and an ask match, a transaction occurs and both orders will be filled. In a very liquid market, the orders will be filled almost instantaneously. In a thinly traded market, however, the order may not be filled quickly or at all.
Physical Exchange
At a physical exchange, such as the NYSE, orders are sent to a floor broker who, in turn, brings the order to a specialist for that particular stock. The specialist facilitates the trading of a given stock and maintains a fair and orderly market.
If necessary, the specialist will use his or her own inventory to meet the demands of the trade orders.
Electronic Exchange
On an electronic exchange, such as NASDAQ, buyers and sellers are matched electronically. Market makers (similar in function to the specialists at the physical exchanges) provide bid and ask prices, facilitate trading in certain security, match buy and sell orders, and use their own inventory of shares, if necessary.
Limit Orders
A limit order is an order to buy or sell a certain security for a specific price.
One thing to keep in mind is that you cannot set a plain limit order to buy a stock above the market price because a better price is already available. So if you wanted to purchase shares of a £100 stock at £100 or less, you can set a limit order that won’t be filled unless the price that you specified becomes available.
Similarly, you can set a limit order to sell a stock when a specific price is available. Imagine that you own stock worth £75 per share and want to sell if the price gets to £80 per share. A limit order can be set at £80, which will be filled only at that price or better. Just remember that you cannot set a limit order to sell below the current market price because there are better prices available.
Stop Orders
Stop orders come in a few different variations, but they are all effectively conditional based on a price that is not yet available in the market when the order is originally placed. When the future price is available, a stop order will be triggered, but depending on its type, the broker will execute them differently.
Many brokers now add the term “stop on quote” to their order types to make it clear that the stop order will be triggered only when a valid quoted price in the market has been met. For example, if you set a stop order with a stop price of $100, it will be triggered only if a valid quote at $100 or better is met.
A normal stop order will turn into a traditional market order when your stop price is met or exceeded. A stop order can be set as an entry order as well. If you wanted to open a position when the price of a stock is rising, a stop market order could be set above the current market price, which turns into a regular market order when your stop price has been met.
Pros and Cons of Limit and Stop Orders
With a limit order, you can set the ultimate price level that you’re willing to accept on a transaction, but you risk your order going unfilled. A stop order allows you to enter or exit a position once a certain price has been met, but since it turns into a market order, it may be filled at a less favourable price than you expected.