On a frozen winter's night in a remote northern fishing village, a young boy named Nicholas is orphaned when his father is drowned at sea. His mother braves the raging storm to get medical help for Kati, the younger sister, and leaves Nicholas to sit by her bedside. When the villagers arrive at the cottage in morning, he learns that Kati has died of a fever, and his mother is killed by a falling tree as she passes through the forest.

The fishermen's wives gather to discuss how Nicholas will be cared for, and decide that if each family takes him in for one year, he will reach an age to care for himself. So it is that Nicholas moves in with his first family-for-a-year on Christmas Eve. He hides in a closet and cries himself to sleep.

The next day, Christmas, is sorrowful for Nicholas but brightened by the company of the family's children, two girls and especially Otto, who becomes Nicholas' life-long friend. Nicholas has learned to carve by watching his father repair fishing gear and as his father's knife is his only inherited possession, he uses it to repair Otto's broken Christmas toy.

When a year passes and it's time for Nicholas to move on to another family, he carves a doll and a chair for the girls and a toy sleigh with beautiful carved runners for Otto. The children are so pleased with the toys that Nicholas promises, "Next year, I'll know how to make better toys and I'll make you some next Christmas, too." That is how every home where Nicholas the wandering orphan stayed, he left gifts for each child and each child in every family came to expect a Christmas gift from Nicholas.

The story proceeds to weave an incentive for hanging the first Christmas stocking; for designing the first red suit; for replacing his old horse with reindeer; for resorting to go down the chimney to leave gifts; for the occasion of the first Christmas tree; and other favorite legends and traditions surrounding Christmas.