Background Information on Corporations and Stocks

The earliest businesses were owned and run by one person or a family. This type of business is called a single proprietorship, which means that the business has a single owner. If two or more people wanted to own and run a business, they could form a partnership. In a partnership, any of the partners could make decisions for the business and could enter into contracts and obligate the business, including the other partners, to do such things as make purchases, contract debts, perform services, etc. Each of the partners shared in the profits of the business and could be liable for any debts or losses of the business. If the business did not have enough money to pay its debts, then the partners could be required to pay the debts off from their personal assets, savings, homes, whatever they had.

As the economy of Europe expanded during and after the Age of Discovery, some businesses became too large or too risky for the single proprietorship or partnership kinds of business. For example, the cargo in an English ship trading with China or India might be far more valuable than the ship itself. Up until this time, the ship's owner was responsible for the value of the cargo. Thus, if the ship sank, the ship's owner had to pay for the lost cargo. It soon became obvious that shipowners could no longer afford to do business this way.

The vast riches involved in the trade with the Orient and other parts of the world required a new economic system. More money was needed by businesses in order to profit from new sources of trade. A way to deal with the possibility of huge losses was also needed.

Used since the Middle Ages as a type of organization for towns, universities, monasteries, and guilds, the corporation was developed as a business organization to deal with these new problems and opportunities. One of the first corporations, the East India Tea Company, was chartered by Queen Elizabeth I in 1600. People could invest their money in the corporation, putting together the resources needed to carry out the expanded trading operations. The liability of the corporation was limited to its actual assets. Thus, if it went bankrupt, the shareholders lost their in, vestment but did not have to pay the corporation's debts with their own possessions.

At the same time, to protect against the possibility of huge losses, the insurance company was developed. Many people could pay a relatively small amount into an insurance fund. If a few of those so insured had losses. The insurance would reimburse them. The corporation and the insurance company were developed together to minimize risks and maximize profits.

By law, the corporation is treated as if it were a person in many ways. It must obey the law. It can be sued. It can be held liable for mistakes or negligence. It must pay its debts. But the corporation has indefinite life. It can continue as the same factitious person, even if all of the original stockholders sell their stock or die. Some corporations are hundreds of years old.

With a corporation, investors pay money into the company and receive shares of stock to show the percentage of their ownership in the business. The stockholders of the company select a board of directors to make decisions for the stockholders. The board of directors hires managers who actually run the company.

If a stockholder no longer wants to be one of the owners of the company, he can sell his stock. Stock is normally sold through brokers, who make it their business to find people who want to buy stock and people who want to sell stock. For a fee, the broker makes the transactions for the buyers and sellers. The person who buys the -stock then becomes an owner of the company. When stock is bought, the money goes to the person selling the stock, not to the corporation. Only when a new corporation is formed or when a corporation expands and issues new stock does the corporation itself sell the stock.

The price of stock in a company depends on how many people want to sell the stock, how many people want to buy the stock, and how much those people think the stock should be worth. The price of stock can go up or down even though there has been no change in the business itself. National and international events often affect stock prices.

Corporations can own stock in other corporations. Sometimes one corporation will take over another by buying a majority of the stock in the second corporation. The corporation which takes over can then have their own candidates selected as the board of directors and control the hiring of the managers of the corporation taken over. If a majority of the stockholders in two companies are in agreement, two corporations can merge by having the stockholders in one corporation turn in their stock in exchange for stock in the other corporation.

Corporate takeover attempts often happen because one corporation wants to acquire the valuable assets of another. These might be securities, land, or a subsidiary business which could be sold for a profit. The corporation attempting the takeover may have little regard for the welfare of the stockholders or employees of the target corporation. Sometimes, the corporation taken over is merged into the other corporation and loses its identity. At other times, it may be broken into small pieces and sold off to other corporations. Takeovers which are resisted by the target corporation are expensive for both the corporation making the attempt and the target. The battle between corporations can leave both corporations in debt, whether the takeover is successful or not.

People buy stock for a number of reasons. Individuals may own stock in small corporations or acquire large blocks of stock in national corporations in order to influence or control the management of the corporation. Most people, however, buy stock as an investment, as a way of making money with savings.

When money is invested in a savings account or bonds, the investor receives interest on the amount of money, "the principle" invested, but the principal itself remains constant. When, however, money is invested in stock, the stockholder not only receives dividends if the company is making a profit, but the value of the stock may also go up.

The stockholder would then be able to sell the stock later for a profit in addition to the income already received as dividends.

Investors who plan to keep the stock for a long period of time are generally more concerned about the amount of the dividends and a slow, steady growth in the value of the company than in short term fluctuations in the price of the stock. Speculative investors purchase the stock in hopes that the price will go up fairly quickly. If it does, they sell the stock for a profit. Speculative investors may not be concerned with dividends or the longer term future and health of the company.

In selecting stocks to purchase, an investor must first decide on his investment objectives and the level of risk he is willing to take. Normally, the safest investments also have the lowest rate of return. Generally, the level of risk rises steadily as the amount of potential profit increases. Many stocks have a long history of slow, steady increase in value with a reliable record of dividends. Other stocks have followed a pattern of sharp increases and decreases in price, providing the investor with the opportunity for quick and substantial profits or losses, depending on the timing of his purchases and sales.

To identify good stocks to buy, for a reasonable expectation of profit, potential investors should first look at the economy and the stock market as a whole. The investor must determine whether the value of stocks in general, which reflect public expectations for the future of the economy as a whole, is rising or declining. Stock market indexes, such as the Dow Jones Average, or the American Stock Exchange Index, are useful for this purpose.

The next step is to identify particular industries or types of businesses which are currently doing better than the average of all businesses or which businesses and industries could be expected to do well in the future. Some examples of particular types of industries which might be doing better or less well than the economy as a whole are computer companies, defense contractors, health related companies such as hospital chains, public utilities, railroads, oil companies, retail merchandising chains, pharmaceutical companies, aerospace related industries, etc. The list could include dozens more. See how many more separate industries you can think of.

After selecting one or more industry areas that look promising, the potential investor should then study the individual companies in that industry. Sometimes a company will do all of its business in one industry manufacturing only farm equipment, for example. Sometimes a large company will conduct business in several industries. A corporation might be involved in manufacturing farm equipment, automobiles, and military equipment. If a company has divisions in different industries, then the investor must look at each of these industries and the company's level of involvement in each to determine the company's prospects.

In assessing the investment potential of a particular company, the investor should attempt to determine the company's past performance, the strength and competence of the corporate management, advantages which that particular company has over other companies in the industry size, advantageous location, a particularly valuable patent or popular product, etc. The investor should also attempt to assess any problems which the company has pending lawsuits or legal claims, labor problems, contracts with an unpopular client or country such as South Africa, etc. Sources of such information can be found in the Wall Street Journal, national news magazines, trade journals, or industry publications, the company's annual reports, and from stock brokers and investment counselors.

After going through all of these steps, it is then possible to make a judgment about which companies have the most promising investment potential. For a long-term investment, the best choice is a growing company in a healthy industry with a good ratio of dividends to stock price, called the price-earning ratio. But there is always the possibility of unforseen factors such as storms, wars, new inventions, corporate changes, any of which may affect one company or industry more than another. It is usually wise to spread investments over several companies that look good rather than to place all of the investment in one company.

For short-term, speculative investments, the investor looks for factors which could cause the stock of a particular company to go up. Crop failures in one industry might cause price rises and profits for companies producing a substitute product. A new invention might mean big profits and rapidly rising stock prices for the company holding the patent. But for successful speculative investment, it is necessary to identify and purchase the stock before other speculators have already driven the price up, and to know when to sell a stock before the price goes down.