What is Stock?

In Finance markets, stock is the capital raised by a corporatio through the issuance and distribution of shares. A person or organization which holds at least a partial share of stocks is called a shareholder. The aggregate value of a corporation's issued shares is its market capitalization.

Buy a share of Apple and you acquire a tiny sliver of the eletronic giant, tying your fate to that of Steve Jobs, for better or worse. This is ownership in the most literal sense: You get a piece of every desk, contract and trademark in the place. Better yet, you own a slice of every dollar of profit that comes through the door. The more shares you buy, the bigger your stake becomes.

How is a stock valued?The stock market itself is basically a daily referendum on the value of the companies that trade there. All those guys screaming at each other? Their job is to take in the day's news and distill it down to a single question: Will it help the companies I own make money in the future, or will it prevent them from doing so? If Apple loses a court battle to the Justice Department, look for its shares to fall. But if strong economic numbers come out promising better iPOD sales, traders will buy with a vengeance.

Earnings are the supreme measure of value as far as the market is concerned. Wall Street is obsessed with them. Companies report their profits four times a year and investors pore over these numbers -- expressed as earnings per share -- trying to gauge a company's present health and future potential.

The market rewards both fast earnings growth and stable earnings growth. Stock traders will even pay up for a money-losing company that promises to earn a lot in the future (witness 1998's explosion in Internet stocks). Things the market will not tolerate are declining earnings or unexplained losses. Companies that surprise Wall Street with bad quarterly reports almost always get punished.

What about risk?While history shows that stocks will rise given the fullness of time, there are no guarantees -- especially when it comes to individual stocks. Unlike a bond, which promises a payout at the end of a specified period plus interest along the way, the only assured return from a stock is if it appreciates on the open market. (While many companies pay shareholders dividends out of their earnings, they are under no obligation to do so.) The worst-case scenario is that a company goes bankrupt and the value of your investment evaporates altogether. Happily, that's rare. More often, a company will run into short-term problems that depress the price of its stock for what seems an agonizingly long period of time.

For all the risk, however, there are ways to manage your exposure. The best is to diversify by owning a variety of stocks. That way, no single company can harm you. It's also important to remember that investors are well compensated for rolling the dice with equities. Historically, the long-term return from stocks is about 11% annually, while bonds -- which are less risky -- return just 5.2%. Over time, that spread can make a huge difference in the earning power of your savings.

Along with ownership, a share of stock gives you the right to vote on management issues. Company executives work at the behest of shareholders, who are represented by an elected board of directors. By law, the goal of management is to increase the value of the corporation's equity. To the extent this doesn't happen, shareholders can vote to have management removed.

That's the way it is supposed to work, anyway. As we noted above, one of the grim realities of the stock market is that individual investors rarely amass enough stock to be able to exert any tangible influence over a company -- that's left to big institutional shareholders or groups of company insiders. Consequently, it behooves you to carefully research management's competence before you buy a stock. And the best measure of that may be the company's ability to consistently deliver earnings over time.