Stocks—also known as company shares, equities or securities—are a fundamental part of many investors’ plans to build wealth. While stocks have historically delivered strong returns, they also come with risk, and it’s possible for a stock to lose value in the short term. A stock’s price is influenced by both objectively measurable changes in business conditions and the economic environment, as well as subjective investor emotion.
In a legal sense, a share of a stock represents ownership of the portion of a company’s net realizable asset value that would remain after all assets are liquidated (at market prices) and all liabilities are satisfied. But a stock’s most important attribute is the fact that it represents claims on future earnings potential and current cash flow.
Companies issue stock to raise capital and expand their businesses. They typically sell it on a public stock exchange like the New York Stock Exchange or Nasdaq, where investors can buy and sell shares of a company. As a shareholder, you make money when the company’s stock price increases and when it pays dividends. Some shareholders can also vote at shareholder meetings and receive special protections from a company’s creditors in the event of bankruptcy.
There are many different types of stocks, which differ in characteristics including voting rights, ownership control and the size of the company. For example, a class A stock may have priority access to liquidity, while a class B stock might carry less voting rights. Different stocks may also be classified as large-cap, mid-cap or small-cap. Other distinctions include whether a stock is blue chip, which indicates that it’s from a well-known, stable company; or growth, income or value, which point to companies poised for future gains.
When choosing a stock, consider not only its market price but its fair value—an assessment of a company’s worth that incorporates thorough analysis and practical methods. Among other things, this involves assessing intrinsic value and analyzing financial statements. But it also requires researching industry trends, examining competitors and studying factors that influence a company’s profitability and competitiveness, such as the presence of intangible assets such as intellectual property and brand recognition or switching costs that prevent customers from easily shifting to another product.
Finally, when investing in a particular stock, think about how it fits into your overall portfolio strategy and goals. Will it help you achieve the level of asset allocation and diversification that you want? Getting answers to these questions takes time and forethought, but it’s critical to your success as an investor.