A stock represents ownership in the assets and earnings of a company. A company issues stock through equity financing, which is the process of selling an ownership interest, or a “stock”, to raise funds for business purposes. This is what differentiates a stock from a bond: bonds are raised through debt financing, in which a company promises money in return for investment. Stocks give one a share in a company’s profits, while bonds are essentially interest on a loan. Additionally, stocks give owners one vote per share to elect company board members, whereas bonds do not give owners the right to vote.
Types of Stock
The two main types of stock are common and preferred. Like the name states, common stocks are the most popular type of stock and contain all the features described in the last section. In contrast, preferred stock provides a fixed dividend. In the case of liquidation, preferred stockowners are paid off first. However, since preferred stocks don’t contain the risks of common stock, they also don’t have the potential for high yields. With their fixed dividends, preferred stocks are similar to bonds.
Common stock can also be divided into classes such as Class A and Class B. The most common reason for doing so is because the company wants voting power to remain within a certain group. For example, Class A may have more voting rights than Class B.
Why Buy a Stock?
People buy stocks for capital gains. Presently, bank accounts and bonds pay out low interest rates. This is why people turn to stocks for income. Stocks are also bought to diversify investments. For example, if someone has a lot of real estate, they may seek to balance this with the purchase of stocks. The same is true if one has money in art, antiques, etc.
How to Make Money on a Stock
The main way to make money on a stock is through appreciation, which is a fancy term for the old maxim: “buy low and sell high.” For example, you buy a stock at $100 and hold onto it until it sells for $200.
Another way to make money on a stock is through dividends, which are additional cash and stock payouts that do not reflect the stock’s overall value. For example, a company may issue a 5% stock dividend, which grants stockholders 5% more stock than they already own. However, not every stock grants dividends. Just because a company has issued dividends in the past does not mean it will do so in the future.
Types of Investors
Before you invest in stock you must decide what type of investor you are going to be. The traditional type of investor is long-term, or a buy-and-hold type. Before buying a company’s stock these people take a careful look at the company and ask themselves: what is this company’s plan, how will it earn money, how long will this continue and what are the risks? The buy-and-hold investor pays special attention to a company’s management team. All companies encounter problems, and great companies have managers who can solve these problems.
Other people invest in stocks simply to short them. This means that the investor sells borrowed stocks, and hopes that the price will decline so he can buy it back at a lower price. An example of shorting a stock is selling a borrowed stock at 20, and buying it back at 10.
Skilled investors also purchase stocks in the short-term. For example, there are hedge fund owners who buy stocks at opening, ride them up, and sell them by the end of the day. To emphasize, this is something that only skilled investors should practice.
When deciding what type of investor you will be, please keep in mind that Warren Buffet, the most successful investor of our era, buys stocks for the long-term. His ideal holding period is forever.
How to Analyze a Stock
The simplest way to analyze a stock is through its balance sheet. The left side of a balance sheet contains assets, and the right side contains liabilities. The way to calculate a company’s net worth is to subtract its liabilities from its assets. Although net worth is usually positive, occasionally even well-regarded companies such as Clorox Wipes displays negative net worth. For example, Clorox Wipes has solid assets and earns money for its stock holders but has shown negative net worth in the past due to heavy borrowing and depreciated assets.
One can also analyze a company through income statements and cash-flow statements. An income statement shows how much money a company is earning, while a cash-flow statement shows how much money a company is receiving.
Although it is important to analyze a company before buying its stock, one should also keep in mind that stocks trade based on perception. If people think a stock is doing well they will buy it, and if they think a stock is doing badly they will sell it.
How to Buy a Stock
The most common way to buy a stock is through a broker. All you have to do is tell your broker which stock to buy, and how many shares. The broker will then execute the trade on your behalf, and receive a commission. An alternative is to go online and execute the trades yourself and pay a lower commission. You can check out a great review on online brokers for Canada and the USA here.
A stock may be purchased at “market order” or “limit order.” Market order allows you to buy the stock at its current price while limited order allows you to wait until the price has reached a certain threshold.
This concludes our short guide to stocks. We hope you use the information and tips contained in this article for prudent and profitable investing. If you are looking for a more in depth guide, Stocktrades provides a great article on how to buy stocks in Canada.
Stocktrades provides stock,personal finance and investing information to beginning and intermediate investors. Started by Dan Kent and Dylan Callaghan in 2016, they aim to bring solid investment solutions to your desktop. You can check them out at http://www.stocktrades.ca