Please explain stocks to me

Factual Questions
1

I am today years old (53) and I have only the most vague idea of how the stock market works.

Let’s say I need $500k to get Homie’s Widgets up and running. So I sell one thousand shares at $5 per. In its first year of operation, Homie’s Widgets grosses ten million and nets one million. So every shareholder gets a thousand dollars, yes? But what about me? Am I left out of the party even though it’s my name on the door? Do I just tell the shareholders I’m goi g to pay myself a salary in the prospectus? So I get to keep some percent that the SEC determines?

Also, has there ever been a case where stocks were bought and sold with regard to a company that doesn’t actually provide a product or service? I get that fortunes have been made and lost on promises that fail to materialize, like a revolutionary medical device that is more of an idea than a thing and it never happens. I mean like a deliberate … well, fraud may not be the right word. Like let’s say Amalgamated Solutions LLC has a slick website filled with stock images of well dressed business people at work, a guy in a hard hat with a clipboard, and a mission statement filled with corporate buzzwords like “scalability” and “leveraging transactional frameworks,” etc. But Amalgamated Solutions LLC doesn’t actually-do- anything. It offers no product or service. But somehow investors are interested in it. Is the SEC going to shut that shit down, or is it a matter of “shame on you for failing to read the fine print”? And has anything like this ever actually happened?

2

No.

The shareholders each hold 1/10th of a percent of the company. That company can decide to pay dividends or put that money to work building the company. The board of directors for the company decides what they want to do with that money; the shareholders vote for the board.

But most founders won’t sell 100% of the company to raise funds. I’m going to simplify your numbers a little for clarity. Suppose you divide the company into 100 shares, each worth 1% of the company. You sell 50 shares for $10000 each, raising your $500K, and you keep 50 shares for yourself. If the company is successful, the value of your 50 shares goes up and that’s how you make money from a successful company. If you want to sell, there’s a market for your shares and you can reap the benefits of your hard work. Until then, you retain control of your company because you have 50% of the voting shares.

In the real world, it’s more complicated than that. Investors may want more control of the company, they may be willing to let you continue to lead with some control of the board. Once the stock goes public anyone can buy shares and vote.

This happens all the time. Not all ideas fail because of fraud. What do you think the dotcom bubble was? Investors were throwing megabux at companies that had an idea and a cool website but never were able to deliver. Other companies like Enron and Theranos grew by lying to investors; and eventually the SEC caught up to them.

3

Quite so. Here’s a CNN Money link that lists 10 such companies.

4

The previous replies were spot-on, but didn’t specifically mention that publicly traded companies have filing requirements that are subject to examination by the SEC. The initial one is the S-1, where you would have to list what the company actually does or sells. You can see what is expected to be included in the summary prospectus here: https://www.sec.gov/files/forms-1.pdf

You can see it includes “a brief statement of the general character of the business done and
intended to be done”. So you could definitely cover it with business-speak gobbledygook, but you can’t actually omit what your business is intending to do.

Then there are ongoing reporting requirements where you are supposed to list how much business you have done, profits and losses, assets and liabilities, that sort of thing. This is where the accounting fraud (see: Enron) can cover your ass for awhile, but eventually investors will probably realize you aren’t actually making any money and your price will fall or the SEC will start snooping around.

You can have a bad idea that investors love, or an impossible idea that investors are willing to take a chance on, or a money-spewing company that is never going to turn it around. But I don’t think you can explicitly have a company that doesn’t actually do or own anything.

5

The final prospectus should be the one used to interpret a company’s financials and business disclosures because the SEC comments in the period between the first S-1 and the EFFECT, then a Final 424 should be released. The SEC wants the company to disclose as much as it can, materially, so a company filing a registration (e.g. IPO) will need to provide disclosures according to the SEC comments before it can sell shares publicly.
So, go with the S-1/A right before the EFFECT (or CERT) is filed or the final 424.

You can actually use Compare function in Word to compare the first S-1 to the final S-1/A to see the disclosures added or changed as per the SEC comments, or you can read the SEC comments on forms UPLOAD on the File number (e.g. 333-xxxxxx) of the subsequent registrations/prospectuses.

6

Should also mention things like preferred shares and special voting rights shares.

If I remember Economics 101 from decades ago… Preferred shares are a separate special class of shares guaranteed a certain amount/portion of the profits before the “common” shares see any dividends. Sometimes too, there would be Class A and B shares.

One of the advantages of shares is also - you own X% of the company, you are entitled to an X% vote on members of the Board of Directors and other important issues. The board provides oversight to the CEO who runs the company day-to-day. Usually, major shareholders with say, 20% or more of the company shares, get a big say in who is on the baord of directors. Usually a corporation’s share are so widely held (unless the founder kept a huge chunk) that the corporation is effectively autonomous, self-governing - the executives nominate board members, and unless they’ve really pissed off a lot of shareholders, the shareholders vote for who the CEO/current board recommend.

Sometimes there are separate classes for shares with different voting rights - i.e. these shares get to vote for board of directors etc., these don’t. Or these shares have 10 times the voting power.

It’s all one big circle-jerk. Google any list of board members of any corporation, and they tend to be CEO’s of other corporations, customers and suppliers and big names in the business. Occasionally a figurehead, like a prominent retired politician or celebrity, or a “conscience” vote like a member of a university faculty.

Generally, the board sets the CEO salary and surprise(!) being CEO’s themselves, believe CEO’s in general should be paid enormous amounts of big bucks, irrelevant of performance. The board themselves are also paid pretty good for just showing up and voting at meetings a few times a year.

Also, many higher up executives are paid with stock options - “In 2 years you can buy X stock from the company at today’s price”. So the driving motivation for any executives is to increase the stock price, no matter what it does to the company after those years are up. This also means a company may (many have lately) buy back shares from the market which provides shares for those stock options, and also buying shares can drive up the price… win win. It also means fewer shares out there, and disposes of profits so they don’t have to be handed out to shareholders.

(side note - the difference between stock option price and current market value is considered income for the executive. For example, Elon Musk in 2022 had a $22B stock option windfall for hitting performance targets with Tesla, resulting in a tax bill of $11B, probably the biggest single amount of income tax anyone any time has ever paid. But, he still ended up with $11B in the bank.)

What a company can do with stocks, what information they must disclose, what they can say and whether it’s misleading, stock price manipulation, trading based on inside information the public does not know - all restricted by the SEC to prevent the smaller stock holders from being screwed. You must disclose buying more that 5%(?) of a publicly traded company, and whether you intend to buy out all shares. if so, you must make an offer for all shares to all holdes. You can’t go to company B and say “we’ll buy your shares in Acme and that will give me 50%”

7

However, there is such a thing as a special-purpose acquisition company (SPAC), which sells shares with the idea of acquiring another unspecified company with the proceeds. So the investors really don’t know what they’re going to get for their money.

8

there are also publicly traded patent assertion entities. Essentially, companies who’s only assets are patent, who do not make any products or offer any services, and who’s only source of income is suing other companies for patent infringement. They are more commonly referred to as “patent trolls”.

9

SPACs don’t always consummate a merger, and if they don’t, the money is returned to the investors. I can’t remember the exact timeframe. They can ask to extend the timeframe.

Preferred shares and different classes of shares aren’t as liquid (can’t be sold as easily) as common stock as issued in IPOs or other primary offerings.

10

Yes! The one example I see a lot is Parkervision.

11

Different share classes enable founders to maintain control over the company in case of takeover attempts or voting against shareholder proposals with which they disagree. E.g. a “Class A shareholder” may mean a class A share has the voting power of 10 regular shares.

12

I saw a mention of this once in a discussion of the mechanics of stock markets and market funds. A share gives you diviends (share of the profits) and voting rights to direct the corporation. Nowadays, dividends are minimal. (back in the 50’s and 60’s it was common that they served the equivalnet of pension income since they paid fairly well). So if you don’t get much dividends and you can’t vote, what’s the point of the shares?

They’re just a gamble that they will go up substantially and some future sucker will buy them. That’s was the whole point of the dot-com bubble. Buy a stock - Google, Apple, Pets.com, MySpace, AskJeeves, etc. - and hope the company, and hence the stock, is worth astronomically more later on due to ther technological prowess.

Also note the company can issue and sell more shares based on a vote of the board (who rpresnt the shareholders). Often this is done to raise extra money, so presumably with this extra cash - say to build another factory - the company is worth more.

Also, shares can “split” - every share becomes 2 or 5 or 10 shares, etc. Many companies prefer their shares to be in the range where investors can afford them - usually in the $20 to $500 range. Since shares in the stock market are (or used to be) bought in groups of minimum 10, it limits the number of people who can buy your shares if the price is in the thousands of dollars. (Tesla stock has split several times.)

13

Doesn’t look like anyone explained what a dividend even is.

A dividend is when the company decides to pay you cash based on how many shares you own. It’s entirely up to the company how they go about this, though. Some companies don’t pay dividends at all, and the only point to owning that stock is the hope that the stock price will go up further. Some companies pay dividends on a regular basis, like quarterly. Others pay dividends on an irregular basis, like if they are flush with cash and don’t know what else to do with it.

If your company is just starting out and cash is tight, you probably won’t pay dividends. That would only come later when you have good cashflow. The investors are hoping that, by instead spending the cash on growing the company, their shares will also become more valuable.

14

To follow a line of thought that @md-2000 covered well, a rise of a stock price certainly benefits the stockholders (or potentially does if they can sell at the right moment) but what benefit does it give to the company itself?

The formal answer is that it does not directly benefit the company any more than a fall in stock prices hurts the company. The stock price is incidental to the revenues, expenses, and profits of the company. The stock price could double but none of that money goes to the company.

Any deeper examination of the question uncovers a myriad of indirect benefits or harms. Theory states that a stock’s price includes the value of holding the stock over a period of time, therefore indicating the sensibility of putting the money into that stock at that time rather than elsewhere. That’s why investors pounce at any changes in the outlook of the economy as a whole in addition to that of the company. If investors see a good future as reflected in a stock’s price, people are presumably more likely, even eager, to do business with that company. Similarly, a good future outlook will often prod a company to release more stock, raising needed funds, diluting the value of current holdings but signaling the hope of future rises to make up for that.

The market is presumed to be rational, in the sense that all public information is available to those who look for it and those who are best informed with settle on current value. Over time, the market functions well and the various stock indexes parallel one another even though they track different stocks. Nevertheless, all individual stocks at individual moments are priced through sheer perception and intuition. Stocks, like molecules in a gas, are statistically predictable but not necessarily individually. Stock prices can vary greatly over short periods of time accordingly even as the company continues to do business as usual.

15

In fact, most companies don’t pay dividends. I tried to find the exact percentage, but failed.

@Dr.Strangelove did a fine job of explaining dividends. If you want a deep dive, here’s an Investopedia article that’s fairly detailed.

(You could do worse than using Investopedia as a source for financial information.)

16

Dividends are a (sometimes varied) percent of profits (or revenues) paid back to shareholders. The amount paid to you is based on how many shares you own and the share price at the time a divided is declared (ex-date).

A lot of tech companies dont pay dividends. Some big companies like Altria (7%) and exxonmobil (5%?) pay a lot. Many people use these as a form of income.

“Special dividends” can be paid when a company spins off a segment or subsidiary as a separate entity, those shares would be in the form of a “special dividend” usually for tax reasons, so shares not cash.

17

Not always. A company can decide to pay any flat amount they choose back to shareholders, even if they’re currently unprofitable. This obviously wouldn’t be too common, since an unprofitable company probably needs that cash, but there’s nothing stopping them.

18

Yes that very rarely happens usually if something causes it to happen. I cant think of an example offhand.

Public companies and “stocks” are an elaborate subject and ideally OP will read about corporate governance, understand prospectuses, what a proxy is, how to interpret financials, what debt or equity is and how companies implement it, M&A, etc. As suggested investopedia is a start.
There is a lot to take in and its difficult to explain comprehensively (and remember everything) in a forum!

As background, I worked for an SEC adjacent company startup about 20 years ago, then the company was acquired, and I left after a few years. Then i was called out of the blue by another SEC adjacent startup about 11 years ago to help them. We were also acquired, but I stayed. So Ive been interpreting SEC filings for the last 20+ years. A lot of my former arm-in-arm coworkers work for shareholder advisory services, but I didnt want to go down that route.

19

That second part is not true. The company announces a fixed amount, like $1.50 per share, well before the ex-div date.

20

True, the $1.5 determination is based on a percent decided on by management, which can be raised or lowered. The share price at the ex date is not the deciding factor on the amount paid, but its not like “dividends are when youre paid cash based on how many shares you own”, the definition of dividends is more complicated than that.