Selling Shares

If you keep the restaurant going, it will probably make at least $75,000 this year -- you know that from your history with the business. Therefore, you can think of the restaurant as an investment that will pay out something like $75,000 in interest every year. Looking at it that way, someone might be willing to pay $750,000 for the restaurant, as a $75,000 return per year on a $750,000 investment represents a 10-percent rate of return. Someone might even be willing to pay $1,500,000, which represents a 5-percent rate of return, or more if he or she thought that the restaurant's income would grow and increase earnings over time at a rate faster than the rate of inflation.

The restaurant's owner, therefore, will set the price accordingly. You might price the restaurant at $1,500,000. What if 10 people come to you and say, "Wow, I would like to buy your restaurant but I don't have $1,500,000." You might want to somehow divide your restaurant into 10 equal pieces and sell each piece for $150,000. In other words, you might sell shares in the restaurant. Then, each person who bought a share would receive one-tenth of the profits at the end of the year, and each person would have one out of 10 votes in any business decisions. Or, you might divide ownership up into 1,500 shares and sell each share for $1,000 to make the price something that more people could afford. Or, you might divide ownership up into 3,000 shares, keep 1,500 for yourself, and sell the remaining shares for $500 each. That way, you retain a majority of the shares (and therefore the votes) and remain in control of the restaurant while sharing the profit with other people. In the meantime, you get to put $750,000 in the bank when you sell the 1,500 shares to other people.

Stock, at its core, is really that simple. It represents ownership of a company's assets and profits. A dividend on a share of stock represents that share's portion of the company's profits, generally dispersed yearly. If the restaurant has 10 owners, each owning one share of stock, and the restaurant makes $75,000 in profit during the year, then each owner gets a dividend of $7,500. A large company like IBM has millions of shares of stock outstanding -- about 1.7 billion in February 2004 (see Quicken:International Business Machine for details). In this case, the total profits of the company are divided by 1.7 billion and sent to the shareholders as dividends.

One measure of the value of a company, at least as far as investors are concerned, is the product of the number of outstanding shares multiplied by the share price. This value is called the capitalization of the company.