Stock is the ownership share of a public company. Companies issue stocks to raise money to run their businesses and to grow their business and profits over time. Investors buy these shares, and if the company does well their returns are through increased share prices, dividend payments or both. Over the long term, the stock market averages about a 10% annual return.
Most people know that a company’s stock is traded on the stock exchange, where it is bought and sold. What many don’t realize is how complex the financial industry can be, and how much of a role that complexity plays in what you get out of your investments.
When you own a stock, you own a small portion of a company, and are therefore at risk to lose your investment if the company does poorly. You may also gain money from the company by earning dividends and through capital gains, which are profits you make when you sell a stock for more than you paid to purchase it.
As a rule, larger companies are more stable than smaller ones, but they have less room for growth, so it is important to keep your investments diversified across a variety of industries and types of companies. The stock market also offers a wide range of trading options, from very low-risk exchange-traded funds to high-risk derivatives.
Companies are often classified by how they operate, such as technology or health care. This helps investors find groups of companies that might react in similar ways to changes in the economy. For example, if the economy is slowing, the consumer discretionary sectors (which include things like restaurants and shopping malls) may take a beating, while staples (like grocery stores) tend to fare better, as people still need to spend money on food.
Another way to classify stocks is by their valuation, which can be based on a number of factors. A “value” stock is one that trades below what the market would expect based on its earnings, sales and other fundamental information. At the opposite end of the spectrum are “growth” stocks, which are stocks that are expected to grow at rates higher than the overall market’s expectations.
A stock’s price, or how much someone will pay for it in the marketplace, fluctuates constantly throughout a trading day, depending on demand and supply. When you sell your shares for more than you purchased them, you make a profit known as a capital gain. Similarly, if you sell your shares for less than you purchased them, you make a loss known as a capital loss.
Most stocks also entitle shareholders to voting rights in corporate governance decisions, but this is not always a big deal for individual investors. In general, however, the more a company grows in terms of sales and profits over time, the more its stock is likely to rise. This is because investors generally see future growth in a company as the best path to making money, and are willing to pay a premium for it.