Lesson 1 of 7
What a share actually is
A share is a small, last-in-line claim on a company's profits and assets, ranked behind every supplier and lender.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A share is a small slice of ownership in a real company, ranked behind every other claim on it.
- It gets paid last: after lenders, suppliers, employees and any preferred stock.
- Its quoted price changes every day. The claim underneath it does not change with it.
A share is a small slice of one real company. It gives you a claim on what that company earns and on what it owns, and that claim sits behind every other claim on the same business.
Who is paid first if the company fails
Paid first
- Secured lenders · paid from the assets they lend against$300m30%
- Suppliers, bondholders, other creditors$200m20%
- Preferred stock$100m10%
- Common shareholders · whatever is left over$400m40%
Paid last
Total$1,000m
A claim behind every other one
Every business owes money to more people than its shareholders. Employees are owed wages. Suppliers are owed invoices. Lenders are owed interest and principal, on a schedule set out in a contract. If the company fails, lenders secured on its assets are usually paid first. If the company has issued preferred stock, those holders come next, with a fixed claim ahead of everyone below them.
A common share is what is left after all of that: not a fixed amount, but a right to whatever remains, split among however many shares exist. That is why it is called a residual claim, and why it carries both the most risk in the stack and, when the business does well, the most upside.
One share, one fraction
A share is defined by how many others exist alongside it. Own 10 of a company's 1,000 shares and you own 1 percent of it. That is 1 percent of the profit, 1 percent of what it owns after its debts, and usually 1 percent of the vote. Issue another 1,000 shares and your 10 now stand for half a percent, not one. The claim is real, but it is a claim on a share of the whole, and the size of that whole can change.
Profit per share equals Profit divided by Shares in issue.
Example$5,000 ÷ 1,000 = $5.00
What being last actually buys you
Being last cuts both ways. If the business fails, a common share can be worth nothing: every other claim in the stack is paid first, in full, before any of it reaches you.
But you can never be asked to pay more than you put in. A supplier or a lender can chase a failed company for what it is owed, and no one can chase a shareholder for the company's debts. And unlike the fixed claims above it, a common share has no ceiling. A bond pays back its face value and stops there. A share's claim on future profit has no cap.
The price is not the claim
None of this changes on the days your shares get a new quoted price. Graham described that daily quote as coming from a business partner he called Mr Market: moody, always ready to buy or sell, and never owed the final word on what your claim is worth. Buffett retold the parable in his 1987 letter, written after that October's crash: use Mr Market's prices when they suit you, and never take his word on what the business is worth. Your 1 percent in the example below was still 1 percent of it the day after the crash.
Check yourself
A company has 500 shares and earns $2,000 this year. What is the profit per share?
- $0.25
- $4.00
- $2,000
Show the answer
Answer: B.
$2,000 divided by 500 shares is $4.00 a share, whether or not any of it is paid out as a dividend.If a company fails, in what order are its claims usually paid?
- Common shareholders first, then lenders
- Lenders and suppliers first, common shareholders last
- Whoever asks first
Show the answer
Answer: B.
Operating claims and debt are paid before any equity. Preferred stock sits between the two. Common shareholders get whatever is left, which can be nothing.What is the most a common shareholder can lose if the company fails?
- Nothing, a share cannot lose value
- What they paid for the shares
- A share of whatever the company still owes its lenders
Show the answer
Answer: B.
A shareholder's loss stops at what was paid in. Unlike a partner in an ordinary business, a shareholder is never asked to cover the company's remaining debts.Sources
- Graham, The Intelligent Investor, revised edition 1973, chapter 8, on Mr Market.
- Berkshire Hathaway shareholder letter, 1987, restating Mr Market in the report written after the October crash.
- US Bankruptcy Code, Chapters 7 and 11, and the absolute priority rule, on the order of claims when a company fails.
What this leaves out
- The capital structure figure is illustrative. A real company's own claims, and their order, are set out in its debt agreements and its charter, not by this lesson.
- Preferred stock varies by company: some carries no vote, some converts to common. This lesson describes only its general place in the stack.
- Some companies issue common shares with extra votes, or none.
- Nothing here is advice about any security.