It's worth repeating that when you hold a stock, you own part of a company. Part of being an owner is understanding the financial underpinnings of any given business, and this lesson will provide an introduction.
The main purpose of a company is to take money from investors (their creditors and shareholders) and generate profits on their investments. Creditors and shareholders carry different risks with their investments, and thus they have different return opportunities. Creditors bear less risk and receive a fixed return regardless of a company's performance (unless the firm defaults). Shareholders carry all the risks of ownership, and their return depends on a company's underlying business performance. When companies generate lots of profits, shareholders stand to benefit the most.
As we learned in Lesson 101, at the end of the day, investors have many choices about where to put their money; they can invest it into savings accounts, government bonds, stocks, or other investment vehicles. In each, investors expect a return on their investment. Stocks represent ownership interests in companies that are expected to create value with the money that is invested in them by their owners.
Money In and Money Out >>