Shares vs. Stocks: Understanding Financial Ownership Units

What Are Shares?

Shares are units of ownership in a company that investors can purchase. The terms "shares" and "stocks" are often used interchangeably; however, they are technically distinct. "Stock" is the financial instrument a company issues, and a "share" is a single instance of that financial instrument.

Companies can issue common or preferred shares, which differ in who can purchase them and their perks. Preferred shares have priority over common shares (of which there are also many more) during distributions. Shares are non-reimbursable, but issuers can repurchase them from investors. They can also redeem them if a set call price is specified at the time of issue.

How Shares Function in the Corporate Structure

When establishing a corporation, owners may choose to issue stock to raise capital. Companies then divide their stock into shares, which are sold to investors. These investors are generally investment banks or brokers that, in turn, sell the shares to other investors individually or through instruments like a mutual fund or exchange-traded fund.

Shares are the equivalent of ownership in a corporation. Because they represent ownership, not debt, there is no legal obligation for the company to reimburse the shareholders if something happens to the business. However, some companies may distribute payments to shareholders through dividends. Others may elect not to do so, preferring to put all revenues towards operation, growth, and securing the company's future.

Issuing and Regulating Company Shares

A company's board sets a limit on the number of shares it can issue, known as authorized shares. Issued shares are those actually sold to shareholders. For example, a company may authorize 10 million shares but issue only 8 million.

Shareholders can vote to change the number of authorized shares, which affects ownership stakes. They meet to reach an agreement if they decide to increase this number.

The shares of publicly traded companies are listed on public exchanges, generally through a process called an initial public offering (IPO). This is an expensive, highly regulated, and lengthy process in which a company goes through fund-raising phases and scrutiny by regulators.

The issue and distribution of shares in public and private markets are regulated by the Securities and Exchange Commission (SEC). Share trading on the secondary market is overseen by the SEC and the Financial Industry Regulatory Authority (FINRA).

Exploring Different Types of Shares

As mentioned, any company can issue shares, but publicly traded companies are more likely to divide their stock into two different types of shares.

What You Need to Know About Common Stock Shares

Many companies issue common stock, which is divided into shares. These are generally called common shares. These provide the purchasers—called 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 the shareholders of a company to vote on specific corporate actions, elect members to the board of directors, and approve issuing new securities or payment of dividends. In addition, common stock can include preemptive rights, ensuring that shareholders may buy new shares and retain their percentage of ownership when the corporation issues new stock.

Understanding Preferred Stock Shares

Preferred stocks can also be divided into shares, commonly called preferred shares. Compared to common shares, 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, like a dividend 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. This priority treatment reduces the risk even further compared to common shares.

Advantages of Issuing Corporate Shares

If a company wanted, it could issue it's equity as one simple ownership stake and not divide its equity offering. There are obvious reasons why a company wouldn't want to do this; here are some of the benefits of dividing its stock into individual pieces:

• Shares Increase Liquidity: By going public, founders and early investors can sell shares to turn their stakes into cash. Without shares, selling ownership in the open market would be difficult due to lack of liquidity.
• Shares Make It Possible to Give Employee Incentives: Public companies can offer stock options or restricted stock units as part of employee compensation packages. This aligns employee interests with company performance and can be a powerful tool for attracting and retaining talent. The only way this would be possible is if a company had divided equity offerings.
• Shares Diversify Ownership: By issuing shares to the public, a company can broaden its ownership base. This can bring in a diverse group of shareholders with different perspectives, potentially leading to more balanced decision-making when it comes to voting or decision-making. It can also reduce the concentration of control, which some view as a positive corporate governance practice.

What Are Fractional Shares?

Fractional shares are portions of a single full share of a company's stock. Traditionally, investors bought whole shares, but fractional shares let them buy a part of a stock based on how much money they want to invest.

For example, if a stock trades at $1,000 per share, an investor with only $100 to invest could purchase 0.1 shares of that stock. Fractional shares help more people afford to buy and sell stock, especially those with less money to invest.

However, it's important to note that not all brokers offer fractional shares, and there can be limitations on which stocks are available for fractional investing. Additionally, while fractional shareholders typically have proportional rights to dividends, they may not always have voting rights, depending on the broker and the specific arrangement.

The Role of Shares in Determining Market Capitalization

Market capitalization is a measure of a company's total value in the stock market. It's directly related to the number of shares of stock a company issues.

To calculate market capitalization, multiply the total number of outstanding shares by the current share price. Issuing more shares raises the market cap if the share price stays the same. When a company buys back shares, the market cap decreases if the price per share remains steady.

Let's look at an example. A company's stock is trading at $50. The company has 100,000 outstanding shares of stock. Therefore, the company's market capitalization is $5 million. If the price of the stock goes up to $60, the company's market capitalization is now $6 million. If the price stays at $60 and the company issues an additional 10,000 shares, the company's 110,000 total outstanding shares have a market capitalization of $6,600,000.

The reason this is important is because the value of a company isn't inherently in the price per share, it is in the total number of shares multiplied by the stock price. Let's look at another example. Imagine Company A and Company B, each with a stock price of $100. However, Company A has twice as many shares outstanding compared to Company B. This means it has twice the market capitalization (i.e. it is twice as big) even though the stock price is the same.

Comparing Authorized, Issued, and Outstanding Shares

Last, let's touch on the different stages of shares. At the beginning of the article, we talked about the authorized number of shares. The authorized number of shares is the maximum number of shares that a company is legally permitted to issue.

A company issues a different number of shares than it authorizes. Shares issued are those sold to shareholders and are less than or equal to authorized shares. After going public, a company may issue more shares through secondary offerings or stock options.

Last, the company can have an even different number of shares outstanding. Shares outstanding represent the number of shares that are currently held by all shareholders. This includes company insiders, institutional investors, and the general public. This number is equal to the number of issued shares minus any shares held as treasury stock.

Let's look at an example. Consider a technology startup. At its founding, the company set its authorized shares at 100 million in its charter. As it grew and went public, it issued 50 million shares through its IPO and subsequent offerings. The company then repurchased 5 million shares that are now held as treasury stock. The company has 100 million authorized shares, 50 million issued shares, and 45 million outstanding shares.

The Bottom Line

Stock is a broad term for fundraising instruments issued by a corporation. They are sold to investors and traders to raise equity capital. Shares are a unit of ownership in a corporation, issued as preferred or common shares, which come with varying degrees of ownership, governance rights, and dividends.

Brokers offer investing products, such as mutual funds, that fractionalize shares (create smaller shares from the existing shares) to allow investors with limited capital to access the shares.

Corporate boards govern the number of shares they are authorized to issue. The business will then track the number of shares it has issued to all investors (including treasury shares) and the number of outstanding shares it has sold to investors (excluding treasury shares). Market capitalization is a measure of a corporation's size in the market, representing the total market value of all outstanding shares.