Let’s start from the beginning, shall we? I’ve been writing about various financial concepts, ways to make more money and strategies to make it grow. But today I want to get back to basics; What are shares? What are stocks? Why do they exist?
And more importantly, why should you care?!
A new star is born
As always, I’m going to use an example to explain this. Really, I should rename my site to something like Exampling to Freedom – it even has a ring to it 😉
A nice lady named Samantha wants to start a business selling phone cases made of candy – the kind gummy bears are made from. She knows what you’re thinking;
“Nobody is going to want to eat something that’s been in their pockets all day long!”.
As much as she agrees with you, she’s done her research. She’s run the numbers, found suppliers and thinks there is some space in the phone case market for edible cases.
After a bizarre meeting with a bank employee which involved some weird stares and plenty of sarcastic comments, her initial loan of $50,000 is approved. Yay!
A few months later, Samantha opens a store in her town. It’s called Gummy Cases 4U and it’s an instant hit. Everybody wants a gummy case and they love taking bites of it during their day! People of all ages are in love with this product.
Samantha is feeling pretty smug about herself seeing this wild success. And to think some people doubted her! Ha!
Money makes money
After a year or so, Samatha has made up her mind; she is going to expand her Gummy Cases 4U business and open up 5 more stores in nearby towns. She hopes this will make the brand explode with popularity and that gummy cases become the next big thing. The new Tamagotchi – minus the annoyance and attention-grabbing.
After looking around for a while, she finds a handful of investors which are willing to invest a total of $500,000. This will allow Samantha to not only open up the new stores, but to release more products, improve the customer experience and to make her brand well known nationally.
Of course, the investors aren’t giving her all that money due to the kindness of the hearts – they keep a 50% ownership of the whole business. That’s OK though – Samantha knows that if she wants her business to become huge, she needs plenty of money to be invested.
The way businesses divide ownership is by creating shares. Each share is worth an equal percentage of the whole company. In this case, Samantha releases 10 shares overall. She keeps 5 and gives the other 5 to the investors.
This leads me to a very common question that I’ve heard time after time:
What is the difference between a stocks and shares?
There is no difference. It all depends on the phrasing which is used. For example:
- Samantha owns shares of Gummy Cases 4U – a specific company.
- Terry owns stocks – referring to various companies.
Many years later…
Fast forward a several years and Samantha’s business has bloomed. She now has a Gummy Cases 4U store in every major city in the country, and people have adopted her products with much enthusiasm. She even gets people camping outside her stores at night so they can be the first to buy her new models!
The next big step for Samantha and her company is to expand internationally. She thinks the world would be a better place with edible gummy cases. Some analysts have even seen a link between gummy cases sales and a decrease in crime.
The company has estimated that it will now need 3 Billion $ to carry out its ambitious expansion. Samantha sheds a single tear at how far she’s been able to come, and then decides it’s time for an IPO – time to go public.
Entering the big league
This is how it goes: a company will carry out an Initial Public Offering in which more shares are released and offered to the general public. This number if often in the millions.
Remember Samantha had a 50% ownership to the company up until now? Well, she’ll have to forfeit most of her share in the business to get this massive injection of capital, but she’ll end up making more money this way.
Once an IPO has taken place, anyone can buy shares of her company. Shares are also traded in various stock markets, where people will buy or sell, looking to make a profit.
Stocks – excellent money machines
You can buy any stock that’s available to the public by using a brokerage – you can do this online, no need attend anywhere physically. You can be a part owner of any company, which also means you will reap a proportional amount of their profits.
This is the good stuff. The main reason why I invest.
For instance, I hold shares of Johnson & Johnson (notice how I didn’t say stocks!), which I bought a couple of years ago. I am therefore a part owner of Johnson & Johnson, and I’m entitled to their quarterly dividend. This gets deposited directly into my bank account – I don’t even have to do anything.
The best part is that Johnson & Johnson has been paying increasing dividends for 53 years in a row. Their average dividend increase is around 7%.
This may not sound like a lot, but when you increase something by 7%, and then again and again… te results are pretty insane.
To put it another way, one share of the company paid $0.40 a year in 1997. Less than 20 years later, this amount has compounded to $3.15. That’s almost 8 times the initial dividend!
On top of the increase in dividends, the share price has also risen at a comparable rate, meaning that investors have been getting rich from good ol’ Johnson & Johnson during the last half a century.
There are hundreds of companies with similar track records. These companies are huge – the leaders in their fields. I can imagine all of the stocks I own to continue to perform at a similar rate for the next several decades.
This is why I love investing in stocks that pay growing dividends. They are almost perfect money machines, and it is truly passive income – nothing quite compares.
Question for you – do you invest in the stock market? If so, do you go with funds or do you pick stocks yourself?