What Is a Stock?
Let’s get started with the very basics. What is a stock? A stock is just a piece of a company. Stocks are also called shares and although there are some minor differences between these two phrases, they pretty much refer to the same thing.
When you buy a stock you are purchasing a small slice of a company. Large companies like Apple and Amazon have billions of shares that make up their companies. It may seem like a strange concept but buying a stock means owning a portion of a company.
The stock market is made up of buyers and sellers. When you purchase stocks on the open market you are buying these stocks from other investors. When you sell stocks, you are selling to other investors.
This article is meant to be an introduction to stocks and I wanted to bring this up because I know there may be people out there that might think they are buying stocks from a company directly.
Invest With Your Values in Mind
I know I just said it but I am going to say it again to stress this point. When you buy stocks you are buying ownership into a company. I think that sometimes this fact can be very easy to forget.
It can be easy to get so wrapped up in stock tickers and charts that you forget you’re actually investing in a real company. I think it’s really important to remember that you are supporting the companies you invest in.
I am a strong believer in investing according to your beliefs and values. I think that is what is great about ESG investing. Looking at environmental, social, and governance criteria lets you figure out some of the things that are most important to you.
I’m not here to push my own values on you. I’m not going to tell you that you should stay away from a particular stock or sector because of my own personal beliefs. But I will encourage you to consider your own beliefs and values and to incorporate these into your investment decisions.
I’m going to pick on the tobacco industry because they are an easy target. According to the World Health Organization, tobacco kills more than 8 million people each year.
My grandfather was a life-long smoker. He eventually died of lung cancer. For me personally, investing in tobacco companies does not align with my own values system.
There are a lot of people that believe there is no place in investing for this type of thinking and that incorporating your personal values into your investment decisions is just crazy.
Those same people might invest in a morally questionable company and then look to offset that investment through some type of philanthropy elsewhere.
If anything, I think that type of thinking is what is crazy. Would donating to a charity dedicated to lung cancer research make me feel better about investing in tobacco companies? Again, for me personally, I know that this would go against my own core beliefs. I wouldn’t feel any better donating to charities if I knew that my investments were supporting companies that I felt were harmful to our society or our world.
I think it’s really important to consider your own values and the things which are most important to you before making any investment decision.
The Benefits of Owning Stocks
Let’s get back to some stock basics. Why would someone want to buy stocks in the first place? There’s an easy answer to this. Stocks can be a great way to make money. When you purchase a stock, your money becomes tied to the growth and success of the company you are investing in.
Stocks are a great investment opportunity. Historically, stocks offer some of the best returns on your money when compared to other investments.
There are two main ways you can make money from stocks.
- The stock price increases. You sell the stock at a higher price than what you originally purchased it for. This is called appreciation.
- The company provides dividends. You are periodically sent a share of the company’s earnings. These shared earnings are called dividends.
Owning stocks is convenient and as long as you are choosing companies that are liquid, stocks can be traded pretty quickly and easily.
If you have already decided what you’d like to buy, that purchase can be done in just a few seconds. You then own those stocks for however long you’d like to.
When you own individual stocks you’ll want to make sure you’re keeping up with any news related to the companies you own. But other than that, the process of holding stocks is fairly passive. There is very little maintenance required with the ownership of stocks. This is unlike many other investments like real estate.
There are over 6,500 companies listed on the New York Stock Exchange. If you are interested in stocks then you have a lot of options to choose from so choose carefully.
The Risks of Owning Stocks
It’s not all rainbows and butterflies. Stocks come with risk. Stock prices are constantly changing. It’s always best to have a long term perspective in the investing world. But if you were in a situation where you absolutely needed to sell stocks at a particular time, you could potentially find yourself in a bad place.
There is the possibility that those stocks you purchased last month might be priced lower today than what you originally bought them for and if you needed to sell those stocks you would lose money.
There is also the chance that the company you bought shares in is not what you thought it was. If that company experiences financial problems that lead to bankruptcy then there is serious potential you could lose your entire investment.
This is why we research. If you blindly put your money into something you don’t know anything about just because it’s trending, you are gambling; not investing.
Why Do Companies Sell Stocks?
There really is only one reason why companies choose to sell, or issue, stocks. Companies are able to raise money by offering stocks.
Companies may do this in order to continue to grow their business, pay off debt, or any number of other reasons but the underlying motive for issuing stock is always to raise money.
When a private company makes the decision to go public and begin issuing stock, it will go through the steps of setting up an initial public offering (IPO). This allows investors to purchase shares in the newly public company and allows the company to raise money.
In the case of a good company, this is a win-win scenario because both the company and its investors make money together. Although something to be mindful of is there definitely tends to be a lot of volatility with stock prices during initial public offerings.
Common vs. Preferred Stocks
A lot of people don’t know this but there are actually two main types of stock. These are common stock and preferred stock.
Common stock allows the owners of the stock to have a voice in the company and to vote at shareholders’ meetings. Depending on the company, these types of stocks may sometimes grant dividend payouts to shareholders as well.
Preferred stock usually doesn’t give shareholders the ability to vote at shareholders’ meetings. However, preferred stock owners are prioritized over common stockholders in the event the company goes bankrupt. In that scenario, this means that preferred stockholders may receive some payment whereas common stockholders may not. Also, preferred stocks usually offer regular fixed dividends as well.
Types of Stocks
People like to categorize everything and stocks are no different. Stocks typically fall into one of three main categories. These are growth stocks, value stocks, and income stocks. But there can definitely be some overlap and stocks often fall into multiple categories.
Growth stocks come from companies that are expected to grow faster than similar companies in the same space.
The thought with growth stocks is that investors who purchase shares in quickly growing companies will see a return on their money as these companies continue to grow over time.
Value stocks are priced cheaper than what these stocks are actually worth. The idea here is that these stocks can be bought “on sale”, or at a discount.
Value investors make money when the stock price increases once the rest of the market later realizes this pricing mistake. The key to this investing philosophy is that the terms “value” and “price” mean two very different things. Price is what you pay and value is what the investment is actually worth.
Income stocks are stocks that regularly and consistently offer dividends. Remember that a dividend is just a share of a company’s earnings that is distributed to its investors. These are called income stocks because they offer a consistent source of steady income from the dividends that are regularly paid out to investors.
Just keep in mind that dividends are never guaranteed and these could be reduced or even totally eliminated if a company is going through hard times.
I also wanted to briefly discuss market capitalization because this is a very frequent way in which stocks are grouped together. Market cap gives an idea of the size of a company and is based on the total value of a company’s shares. See the table below for a quick look at some numbers and ranges for market caps.
I know market cap can be a little confusing for some people so here’s a simple way to look at it. Take the current price of a stock and multiply that by the number of outstanding shares of the company you are researching. You have just calculated your market capitalization. That’s all there is to it.
Besides market cap, stocks can also be grouped together by almost any number of other criteria. Some other quick examples of categories are company industry or geography.
Mutual funds and exchange-traded funds offer investors an easy way to invest in stocks. Rather than going out and purchasing stocks from one particular company, these types of funds give you the opportunity to invest in a large number of companies all at once.
How to Buy Stocks
Stock exchanges, like the New York Stock Exchange, handle the buying and selling of stocks and other securities.
Most people buy and sell stocks through a broker. This can be done in a number of ways but it is hard to beat the speed and convenience of online stockbrokers.
There are many options to choose from if you’re looking at online brokerages. I have tried about eight or so different brokerages just to see which one best fit my needs. My advice is to do your research and try a few for yourself to see which one you feel offers the best experience and the best tools for you.
Once you’ve chosen your brokerage you just need to fund your account and you can start investing almost immediately.
Start Investing Now
As an investor, time can be your best friend. However, time can also work against you. This all depends on how you utilize this time.
Investing is as powerful as it is because of compound interest. Compound interest is like a snowball rolling downhill. The further along the snowball travels, the larger it gets. The more time you are invested, the more time compound interest has to work in your favor and build your wealth.
If you haven’t yet started investing then what are you waiting for?
What are your favorite types of stocks? Growth? Value? Income? Leave a comment below and let us know why!