Week 16 Day 1: What a Stock Actually Is

A share of stock represents fractional ownership in a business. If Apple has 15.5 billion shares outstanding and you own 100 shares, you own a tiny slice of every iPhone sold, every service subscription, every product line. As the company grows and earns more, your slice becomes more valuable.

Stocks create wealth through two mechanisms. (1) Capital appreciation: the stock price rises as the company becomes more valuable. Apple was $22 per share in 2009 and $190+ in 2024. (2) Dividends: companies distribute a portion of profits to shareholders. Coca-Cola has paid a dividend every quarter since 1920 and has increased it for 62 consecutive years. Total return = capital appreciation + dividends. The S&P 500 has returned approximately 10% annually since 1926 (about 7% from price appreciation and 3% from dividends, though the dividend component has shrunk and price appreciation has grown over time). This 10% average includes the Great Depression, World War II, the 1970s stagflation, the 2000 dot-com crash, the 2008 financial crisis, and COVID-19. Through every catastrophe, stocks recovered and made new highs. The relentlessness of corporate earnings growth drives long-term stock returns.

The theoretical foundation for equity returns comes from the Gordon Growth Model: P = D1 / (r - g), where P is the stock price, D1 is next year's expected dividend, r is the required rate of return, and g is the perpetual growth rate of dividends. Rearranging: r = D1/P + g (dividend yield plus growth rate). For the current S&P 500, D1/P is approximately 1.4% and long-term nominal earnings growth has been approximately 6-7% (real growth of 3-4% plus inflation of 2-3%), implying an expected nominal return of 8-9%. The equity risk premium (ERP) -- the excess return stocks earn over risk-free bonds -- is the compensation for bearing the uncertainty of corporate earnings. Damodaran's 2024 estimate of the forward ERP is approximately 4.6%. This premium exists because stockholders are residual claimants: bondholders get paid first, and stockholders only get what is left. This structural subordination is why stocks must offer higher expected returns than bonds to attract capital.