Why and How Stocks are Offered
To meet their short-term cash requirements corporations usually borrow from banks. But when corporations need long-term financing, they may sell ownership interests in the company (common stocks and preferred stocks) to the public, or borrow from the public by selling bonds. Stocks exist to enable companies in need of long-term financing to sell pieces of the business as stocks (equity securities) in exchange for cash. This is the principal method of raising capital other than by issuing bonds. When the stocks of these corporations are owned by the public at large they are said to be publicly held. These publicly held shares can be traded (sold) to other investors in the stock market, and are in this case, known to be liquid, or readily converted to cash.
There are two major subdivisions to the stock market: the primary market and the secondary market. The primary stock maket is for newly issued shares, both common stock and preferred stock, which are sold by the issuer (the corporation) to the investing public. Stock brokerage firms usually serve as intermediaries in these transactions, buying the new securities at wholesale prices from the issuer and then reselling them to the investing public at premium prices.
The Stock Market's Size
About 4,000 distinct stock issues are now traded on stock exchanges throughout the United States (aka listed securities) and about 25,000 other issues are traded over the counter. Usually, more established companies opt for listing on one or more exchanges, while the over-the-counter (OTC) market is where newer and smaller companies are likely to be traded. The stock market also includes thousands of different mutual funds and thousands of different options to purchase stocks. All mutual funds and some stock options trade OTC. The New York Stock Exchange (NYSE) handles an average daily trading volume of over 200 million shares.
More About Bonds
Investors generally purchase bonds for their relatively safe, stable income. Bonds are priced differently from stocks, and the vast majority are traded OTC. The bond market is even bigger than the stock market. Bonds are priced differently from stocks, and the vast majority are traded OTC. Stocks are equity (ownership) securities; bonds are debt securities. Most investment portfolios contain both stocks and bonds. Finding the right mix of these investment instruments, for various investment purposes and degrees of risk, is known as asset allocation. The bondholder usually receives interest payments rather than dividends, does not have the right to vote, and is promised that, at maturity, the loan value will be repaid. Because a bond is a fixed-income, senior security, its interest payments must be in full before shareholders in that same company can receive any dividends.
Many common stocks and all preferred stocks pay dividends. Most dividend-paying stocks make their distributions on a quarterly basis, more of a tradition in the industry than a legal requirement. The amount and timing of dividend payments are at the discretion of the corporation's board of directors. Most profitable corporations share their profits with their investors by paying them a cash dividend. A general rule is that one-half the profit gets paid to the shareholders, and the remaining half gets reinvested in the company. Companies in aggressive growth mode might opt to reinvest most (if not all) of their profits to speed expansion.
There is no law compelling a company to pay a dividend on its common shares, even if the company is profitable. The board of directors can raise, reduce, or eliminate a company's dividend rate. Dividends on common stock are flexible, therefore, but companies try to maintain a fairly even flow of dividends, increasing the dividend when the company has a growth in net earnings. A company with an annual dividend rate of $1.20 would most likely be paying out $0.30. Dividends may also be paid in additional shares of stock (stock dividends) in lieu of, or in addition to cash.
The expected receipt of dividend income is sometimes incentive enough for investing in a given stock, particularly if the yield on the investment in a given stock, particularly if the yield on the investment exceeds the return afforded by savings accounts or CDs. Stocks that pay out a fairly generous dividend are known as income stocks. These are generally popular with individuals or institutions that are satisfied with the rate of return in an of itself. Such dependable income producers are usually in stable industries such as utilities and food stocks.