What Are Stocks?

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

A corporation's stockholders, or shareholders - sometimes thousands of people and institutions - all have equity in the company, or own a fractional portion of the whole. They buy the stocks because they expect to profit when the company profits. Companies issue two basic types of stock: common and preferred.

COMMON STOCK

Common stocks are ownership shares in a corporation. They are sold initially by the corporation and then traded among investors. Investors who buy them expect to earn dividends as their part of the profits, and hope that the price of the stock will go up so their investment will be worth more. Common stocks offer no performance guarantees, but over time have produced a better return than other investments.

The risks investors take when they buy stocks are that the individual company will not do well, or that stock prices in general will weaken. At worst, it's possible to lose an entire investment - though not more than that. Shareholders are not responsible for corporate debts.

When corporations sell shares, they give up some control to investors whose primary concern is profits and dividends. In return for this scrutiny, they get investment money they need to build or expand their business.

PREFERRED STOCK

Preferred stocks are also ownership shares issued by a corporation and traded by investors. They differ from common stocks in several ways, which reduce investor risk but may also limit reward. The amount of the dividend is guaranteed and paid before dividends on common stock. But the dividend isn't increased if the company profits, and the price of preferred stock increases more slowly. Preferred stockholders have a greater chance of getting some of their investment back if a company fails.

CLASSES OF STOCK

Corporations may also issue different classes of stock. Some, like Sears' preferred P shares, represent ownership in a specific subsidiary. Others - labeled A,B,C, or some other letter - have specific investment purposes, sell at different market prices or have different dividend policies. There can also be restrictions on ownership.

STOCK SPLITS

When the price of a stock gets too high, investors are often reluctant to buy, either because they think it has reached its peak or because it costs so much. Corporations have the option of splitting the stock to lower the price and stimulate trading. When a stock is split, there are more shares available but the total market value is the same. Say a company's stock is trading at $100 a share. If the company declares a two-for-one split, it gives every shareholder two shares for each one held. At the same time the price drops to $50 a share. An investor who owned 300 shares at $100 now has 600 at $50 - but the value is still $30,000.

The initial effect of a stock split is no different from getting change for a dollar. But there are more shares available, at a more accessible price.

Stocks can split three for one, three for two, ten for one, or any other combination. Stocks that have split within the last 52 weeks are identified in The Wall Street Journal's stock columns with an s in the left hand margin.

REVERSE SPLITS

In a reverse split you exchange more stocks for fewer - say ten for five - and the price increases accordingly. Reverse splits are sometimes used to raise a stock's price. This discourages small investors who are costly to keep track of and may attract institutional investors who may refuse to buy stock which costs less than their minimum requirement - often $5.

BLUE CHIPS

Blue Chips is a term borrowed from poker, where the blue chips are the most valuable, and refers to the stocks of the largest, most consistently profitable corporation. The list isn't official - and it does change.