What Is Stock?

It’s more than just a piece of paper (or in some cases not even that). When you buy a stock, you’re taking an ownership stake in a company. At some point, just about every company needs to raise money, whether to open up a West Coast sales office, build a factory or hire a crop of engineers. 

In each case, they have two choices: 1) Borrow the money, or 2) raise it from investors by selling them a stake (issuing shares of stock) in the company. Own a share of stock, and you are a part owner in the company, with a claim (however small it may be) on every asset, and every penny in earnings.

Now, typical stock buyers rarely think like owners, and it’s not as if they actually have a say in how things are done. Owning 100 shares of Microsoft makes you, technically speaking, Bill Gates’ boss, but that doesn’t mean you can call him up and give him a tongue-lashing.

Nevertheless, it’s that ownership structure that gives a stock its value. If stockowners didn’t have a claim on earnings, then stock certificates would be worth no more than the paper they’re printed on. As a company’s earnings improve, investors are willing to pay more for the stock.

Over time, stocks in general have been solid investments. That is, as the economy has grown, so too have corporate earnings, and so have stock prices.

Since the end of World War II, the average large stock has returned, on average, 11 percent a year. If you’re saving for retirement, that’s a pretty good deal — much better than U.S. savings bonds, or stashing cash under your mattress. Of course, “over time” is a relative term. As any stock investor knows, prolonged bear markets can decimate a portfolio. Since World War II, Wall Street has endured a dozen bear markets — defined as a sustained decline of more than 20 in the value of the Dow Jones Industrial Average — including one of the sharpest and longest in history, that began in March 2000.

Bull markets eventually follow these downturns, but again, the term “eventually” offers small sustenance in the midst of the downdraft. The point to consider, then, is that successful investing must be considered a long term endeavor. In order to endure the pain of a bear market, you need to have a stake in the game when the tables turn positive.

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