What exactly is…a stock?

PUBLISHED ON Monday, 16 August 2021

Introduction

A stock is a security – a financial instrument – with which you buy a small piece of a company, which is called a joint-stock company. If you own a share in Apple, a large bank, or a car manufacturer, a piece of the company belongs to you. Now with large corporations, there is so much stock on the market that with one share, your portion is pretty small. But anyway… ;)

Back in the day, you as a shareholder would have an actual security paper for your money in the corporation. It runs virtually today, but it’s still the same principle: a certain amount of money for a stock, and a share in the company for that.

If you own a share, you can sell this at any time to anyone (who wants to buy it) on the stock market. The return you can make on your share changes based on how the corporation you invested in is doing today, its future prospects, and its business model. Positive return is a gain, negative return a loss. A return is the earnings your invested capital yields within a certain time (typically regarded over one year). To find this, you set the difference between the earnings and the investment in proportion to the investment. Sound complicated? Thankfully, it’s not complicated at all. Imagine you invest 100 euros and get back 140 euros after a year. Your return amounts to (140-100)/100, or 40%.

Variation of the return on a share comes from two sources:

Stock price gain

If the demand for the stock of a certain company on the stock market is greater than the supply, the price goes up. One possible reason could be that the company makes such promising products that all sorts of people expect the company to do incredibly well in the future and generate all kinds of profit. They absolutely want to take part in this, and so they gladly buy a share (i.e., a piece of the company) to do so. If you own one of these sought-after shares, you can sell it for more money than you paid for it.

Example: In January of 2021, you buy a share of company A and pay 50 euros for it. Half a year later, in June of 2021, you sell it for 60 euros and thus make a profit of 10 euros. Of course you’ll then have to subtract off taxes and fees, but the fundamental principle is clear. You have achieved, to put it simply, a gain on exchange in the amount of 10 euros.

Another example: In June of 2020, you buy a share of company B and pay 100 euros for it. One year later, in June of 2021, you’d like to sell it back. Now, you just get 70 euros for it on the stock market. This time, you’ve achieved a loss by exchange of 30 euros (70 euros minus 100 euros).

Dividends

If the corporation generates a profit in a given year, it can distribute this among its owners – the shareholders. Alternatively, the earnings can stay in the company and be invested so the company can continue to do even better in the future. Management can use it, for example, to fill in small gaps or to finance new projects. In this case, profits are not paid out. They are instead invested again or, as we say, reinvested.

Once per year, you as a shareholder are invited to what’s known as the stockholders’ meeting of the corporation, where you can speak with all the other shareholders, management, and the board of directors about the state of the company. It’s all of course voluntary – you’re invited and can go, but you don’t have to. ;) By the way, many small shareholders send someone there as a proxy.

At the stockholders’ meeting, the shareholders present jointly decide what portion of the profits will be reinvested and what portion of the profits will be distributed among them (i.e., all the shareholders) as dividends. A dividend gets paid out for each individual share. Someone who owns a lot of shares will receive a correspondingly higher sum of money than someone who owns only a single share.

Okay, let’s sum it all back up. The return on your investment in a joint-stock company is influenced by:

  1. Future expectations. If everything is rosy, the price of a share on the market will rise, because many people would like to have one.
  2. The past. If the company is managed well and turns a good profit, the dividends can turn out to be lush.

To give yourself your first overview of the stock market, the best thing you can do is simply get started and do an internet search for whatever you’re interested in. You can hunt for individual corporations or find out how given stocks generally do for themselves within a national economy (e.g., Germany, China, or the U.S.) or an economic zone (e.g., the eurozone). There’s really not just the one stock market. Who or what someone’s referring to when they talk about the stock market is all over the place.

As for German language media, the go-to market barometer is usually the German Stock Index, abbreviated as DAX. It comprises the largest and most lucrative German stocks and represents more than 80% of the share capital of all the listed companies in Germany. In other words, movement of the DAX reflects movement of all the joint-stock companies in the country pretty well.

Some of the 30 companies of the DAX are Adidas, BMW, Deutsche Bank, Deutsche Telekom, Fresenius, RWE, Siemens, and Volkswagen. The DAX was expanded in September of 2021. It now comprises not 30, but 40 companies. That doesn’t really affect you as an investor, though. It’s just that there is a strong possibility that those companies new to the index will receive quite a lot of attention and be heavily traded on the stock market for a while. Many mutual funds (pots of money you can invest in that have many different stocks inside) track the DAX – if the makeup of the DAX changes, the funds have to add and replace accordingly to be able to track the index.

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