Stock, company shares, equities — however you choose to refer to them, stocks are a core component of many investors’ plans to build wealth. But as with any type of investment, it’s important to understand what they are and how different types may impact your investment strategy.
A share of stock represents fractional ownership of equity in a publicly traded corporation, which operates like a partnership with shareholders that gives them rights and benefits not afforded bondholders. Investors buy and sell these shares to make a profit. Unlike a bond, which operates more like a loan made by creditors to a company in exchange for periodic payments, stocks generate income through dividends, capital gains and other means.
To determine whether a company is worth investing in, you must evaluate its intrinsic value. There are endless metrics and ratios, but the most important point is to look at the whole picture rather than focusing on individual numbers. For example, a company with a defensible economic moat will be able to retain customers and limit competition; companies with large user bases benefit from network effects; and high quality companies often have intangible assets such as brand recognition that add up.
The price of a stock is determined by supply and demand, which changes over time depending on market trends and economic conditions. For example, if there are more buyers than sellers at a particular moment, the stock price will rise and vice versa. The price at a given moment is the product of the company’s total market capitalization (the number of outstanding shares) and the company’s float (the number of shares available for sale).
In addition to evaluating a company’s financial health, you must also consider how it’s likely to perform in the future. To make this determination, you should compare it to its competitors and to market and sector indices.
It’s a good idea to constantly monitor your stocks by reviewing your account statements, following industry news and checking out market and economic trends. This is important because there are plenty of instances where a bad business decision by management results in shareholder losses, including the bankruptcies of Satyam Computers and Enron.
There are a variety of ways to invest in stocks, including through employer-sponsored retirement plans such as the 401(k) and through mutual funds that hold a large pool of stock from multiple companies. It’s important to decide which type of investments will suit your goals and risk tolerance, and to always invest within your comfort zone. It’s also a good idea to set up automatic transfers from your checking or savings accounts into your brokerage account to avoid the temptation of spending your money on a whim. This is a technique known as dollar cost averaging, which reduces your risk by purchasing stocks over time. It’s also helpful to invest in a variety of assets, such as stocks and bonds, to diversify your portfolio. Lastly, always make sure to consult an advisor to ensure that your investment strategy is on track and in line with your goals.