What Are Stocks?
Stocks are essentially a way to build and grow wealth over time. It is an investment that carries risk by purchasing shares in a company that issue the stock.
The investments in the stock market can create substantial gains. For example, a $10,000 investment in the S&P 500 index 50 years ago would rack you n over $1.2 million today. When done right, investing in the stock market is one of the best ways to build long-term returns.
Why should you purchase stocks?
When you purchase a share of a company, you are essentially purchasing a stake of ownership in the company. Holding onto shares can earn you rights to vote during shareholders meeting for those interested, however single shares may be insignificant to the total vote.
Shareholders do not primarily buy stocks for voting rights, they look to get into positions for generally two reasons:
- Dividends. Some companies offer dividends, which are disbursed to shareholders from the company’s revenue. These dividends are paid typically on a quarterly basis.
- Appreciation. If a stock rises since the time of purchase, you are free to sell that same share for a profit.
Stocks are one of the most basic financial assets an investor can put money in. These assets are found in almost every portfolio as the perk of ownership in a public company can provide advantages to get a good return on capital. These investments can be purchased through exchanges where there are buyers and sellers in what is called the stock market. Essentially, the stock market provides a free market for people looking to add equity in companies that they like and see a positive outlook in the company’s valuation.
For example, a share of Apple (NASDAQ: APPL) purchased at $250 rises 10% to a price of $275. Since you still own that same stock, you are a free liberty to sell that share for a $25 profit, or hold it if you expect the company to continue to grow and increase in value. This is the case for every stock listed on the stock market! Typically, stocks are valued at whatever the company is worth with some speculation behind it too. Companies issue these stocks to public to raise money for all sorts of different reasons, such as real estate, product development, machines, or research.
Depending on the class of stock bought, shareholders are allowed one vote per share during annual shareholder meetings which vote on company management issues. This includes voting for the board of directors, who dictate over the company’s management team. Companies also allow shareholders to vote by proxy if (s)he cannot attend the meeting, given if the shareholder decides to exercise their right to vote. Normally, this is the case in most situations which means that shareholders do not have to be directly involved in day-to-day operations of the company.
Some may ask, why should I invest in a company that do not see big returns through appreciation compared to other companies? Let’s take Coca-Cola (NYSE: KO) for example. In the past three years, the stock has not seen a huge price movement as shares are typically traded around the average price of $47. A major reason why Coca-Cola attracts many investors is because they issue dividends. Warren Buffett, for instance, is a billionaire investor and CEO of Berkshire Hathaway (NYSE: BRK.A) and holds over $22 million in stake. This is a company that he fundamentally likes, as it is rumored that he drinks 5 cans of Coca-Cola products everyday. He also knows that there are a millions of people just like him that will enjoy their products, no matter the global situation.
Dividends, which companies issue to their shareholders, are part of a company’s earnings that are regularly paid. For most companies, dividends are issued on a quarterly basis, but could also be issued semi-annually or annually. Some may elect to issue dividends through cash payments or additional stock in the company, which can be fixed or variable (changeable). Fixed dividends have a set percentage or dollar amount that shareholders receive, while variable dividends are issued based on a company’s performance. Keep in mind that company’s can change their policies on dividends at any time, even in some cases electing to stop them permanently or temporarily.
The quarterly dividend announced by Coca–Cola in February 2019 was 40 cents a share. That represented a yield of about 3.41%, roughly double the average dividend paid by consumer goods stocks. For 2020, that quarterly dividend has increased to $0.41, or a 3.6% yield at current prices. You can think of dividends as an incentive that companies give investors to buy their stock as they share profits with shareholders. In many cases, this secures a good return on your capital by holding stock for a long period of them and not having to worry to much on price fluctuations, as you can make a solid annual return of almost 4%
Types of Stock
Companies have the right to issue different kinds of stock based on ownership rights that a shareholder has. There are two main classes of stock: Preferred and Common stock. Common stock, by name, is what retail investors talk about as most companies issue this type of share. When an investors purchases this type of share, they are granted one vote per stock during annual shareholder meetings.
Preferred stock, in contrast, does not give the shareholder voting rights. They usually come with fixed dividend payment, as common shareholders may or may not receive dividends, and if they do, it comes in the form of a variable dividend. Preferred shareholders must be paid in full before any dividends can be issued. These type of shareholders have priority over common shareholders in the case of a company declaring bankruptcy and having to liquidate its assets.
Fixed and variable dividends can each be beneficial in different situations. A fixed dividend can outperform a variable dividend if a company has a poor quarterly performance or vice versa where a variable dividend can out perform a fixed dividend in the case a company has a good quarterly performance. For example, a fixed dividend is set at $5 from a $100 stock while the variable dividend is 10% when the company outperforms or 2% when the company underperforms. The former would receive $5 each time while the latter would receive $10 or $2.
Companies have the option to customize different classes of stock in any way they want. More often than not, the reason for this is because a company may want to restrict voting rights to a certain group of shareholders; different classes of stock are given different voting rights. For instance, one class of shares are given ten votes per share while the second class are given one vote per share. When there is more than one class of stock, the classes are designated as Class A and Class B. Berkshire Hathaway has two different classes of stock listed on the stock market, BRK.A and BRK.B. Google has two classes – GOOGL and GOOG. In this case, GOOG has no voting rights while GOOGL does.
Stock market indices track the value of a large select number of stocks. You may have heard of the Dow Jones Industrial Average, Nasdaq and the Standard & Poor’s 500 (S&P 500). There are many indexes in the market that show the performance of the overall market and different sectors. The Dow Jones, measures the value of 30 stocks from reputable, profitable businesses, often referred to as blue chip stocks. The S&P 500 as its name suggests, follows stocks from 500 different large companies.
These indexes can work as a benchwork for the performance of a variety of investments. A lot of mutual funds and hedge funds compare their performance with the S&P 500 to see if they beat the yearly yield that this index provides. They also serve as an indicator to see how the market is doing. You’ll hear on the news, ‘the market surged 500 points,’ which is most likely referring to one of the previously mentioned indexes. For intraday trading, you can compare an individual stock to the S&P 500 or Dow Jones to see if it is following the current market sentiment.
How to Buy Stock
Buying stock in a company is easier than you think. It can be purchased in a multitude of ways, including purchasing individual stock through a brokerage, exchange-traded fund (ETF), mutual fund, or directly from the company that is issuing stock. Stock is most commonly bought through a brokerage which allows you to directly invest your money into a stock itself or other types of securities. There are trading commissions and transaction fees that brokers charge for using their services.
The first thing to know when buying an individual stock is learning how to market works and how stocks move. This type of investment is riskier than a cash investment or bonds, but they provide those that take advantage of opportunities to make higher returns over long periods of time. As money compounds, a 10% consistent monthly gain will net you to $1 million from $5,000 in a couple of years. Take a look at some of the strategies that we provide for free to make smarter and better trades!
The S&P 500 generally averages a 7% return over the past 50 years. For comparison, savings accounts have had interest rates at or below 1% over the last few years. Stocks are much more volatile than bonds or other cash investments, as you’ve likely seen when the stock market has massive swings. A company could perform poorly or go bankrupt, causing its stock price to fall, or a larger economic issue, such as the housing crisis, could cause massive increases or decreases in the value of many stocks.