A stock is a type of financial security that represents an ownership interest (shares) in a company. Those who own shares have a proportional claim on the company’s net assets and future earnings. Publicly-traded stocks, also known as common stocks, are a core component of almost every investment portfolio. They offer an opportunity to participate in the success of companies while potentially enjoying significant gains, though they can also expose investors to substantial near-term risks. For that reason, prudent investors tend to diversify their holdings across a wide range of industries and geographic regions.
The value of a stock can increase or decrease, depending on a variety of factors, including market conditions and company news. Over longer periods of time, the prices of well-managed companies tend to appreciate, but not all do so. In addition to price appreciation, stocks can also pay dividends that can be used to purchase additional shares.
Investors who buy and sell shares on the secondary market are known as shareholders or stockholders. When a company issues its initial public offering of stock, the amount of shares it sells and the total price per share are both set at that point. The price of a stock can then be affected by the supply and demand of other investors, as well as the company’s ability to deliver on its business model and growth expectations.
The primary way that shareholders make money is when a company’s stock price rises, which can be the result of a strong economy, positive industry or market news, or both. When a company experiences slowing growth or declining revenues, its stock can decline in value, or even drop out of the market altogether.
For many investors, a primary goal is to earn dividends, which are payments to shareholders of a company that are based on its profits and the current market price of its shares. Unlike capital gains, which are taxed at ordinary rates, dividends are taxed at a lower rate and can be reinvested into the company, or used to offset other income sources, such as wages.
Companies can also choose to use dividend payments to buy back shares, or to reinvest in other growth opportunities. Investors who hold a large percentage of a company’s stock can also exercise voting rights on key governance matters.
Some companies, especially smaller ones, do not pay dividends, while others may have to delay or cut their dividends if they experience a decline in performance or unexpected costs. Regardless, a company’s dividends can make or break its stock’s value over the long term. Moreover, it is important for investors to avoid establishing highly concentrated positions in one or more stocks, which can be very risky. This is why many investors use mutual funds and exchange-traded funds to build their portfolios.
