What Are Shares? How They Compare to Stocks

What Are Shares?

Shares are units of ownership in a company. The terms "shares" and "stocks" are often used interchangeably, but they are technically different. "Stock" is the financial instrument a company issues, and a "share" is a single instance of that financial instrument.

Understanding Shares

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.

How Shares Are Issued and Regulated

Generally, a company’s board of directors is given a specific number of shares that can be issued. These are called authorized shares. Issued shares are the number of shares sold to shareholders and counted for ownership purposes. So, a corporation might have 10 million authorized shares but only issue 8 million.

Because shareholders’ ownership is affected by the number of authorized shares, shareholders may vote to limit that number as they see appropriate. When shareholders want to increase the number of authorized shares, they meet to discuss the issue and establish an agreement. When they agree to increase or decrease the number of authorized shares, a formal request is made to the state through filing articles of amendment.

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).

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.

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.

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.

Benefits of Offering 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: Going public and issuing shares provides an exit strategy for founders and early investors. It allows them to convert their ownership stakes into cash by selling shares on the open market. If these early investors were stuck with just one claim of ownership, it would be much more difficult to trade that ownership in the open market because there would be no 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.

Fractional Shares

Fractional shares are portions of a single full share of a company's stock. Traditionally, investors could only purchase whole shares, but fractional shares allow investors to buy a slice of a stock based on a dollar amount rather than the number of shares.

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. The goal of fractional shares is to make it more accessible for a broader range of investors to buy and sell stock, particularly those with limited capital.

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.

Shares of Stock and 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.

Market capitalization is calculated by multiplying the total number of outstanding shares by the current price per share. When a company issues more shares, it increases the total number of outstanding shares. If the share price remains constant, this would lead to an increase in market capitalization. If a company buys back its own shares (reducing the number of outstanding shares) and the share price remains the same, the market cap would decrease.

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.

Shares Authorized vs. Issued vs. Outstanding

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 can have a different amount of shares issued. Shares issued refers to the total number of shares that a company has actually sold or distributed to shareholders. This is always equal to or less than the number of authorized shares. When a company first goes public through an initial public offering, it issues a certain number of shares. Over time, it may issue additional shares through secondary offerings or employee 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

Shares are units of stocks issued by a corporation that represent ownership. They are sold to investors and traders to raise capital for the company. Many businesses issue stocks and shares when they need funds for research and development, expansion, or other growth opportunities.