Stocks (or equities, as they are also called) are a security that represents partial ownership of a publicly traded company. Companies issue stocks to raise money and grow their businesses. Investors purchase stocks in the hopes that their value will rise over time.
Stock prices fluctuate on a daily basis as a result of supply and demand. At any given moment, the stock market has a limited amount of shares available for sale—this is known as the float. The price at that instant is the product of a share’s current market capitalization and the number of shares investors wish to buy at that exact moment. The higher the float, the higher the stock price. A company’s float can be reduced through sales or buybacks.
The value of a stock also reflects the market’s expectations about how a company will perform in the future. Investors use a variety of tools to evaluate a company’s performance and prospects, including the price-to-earnings ratio, the price-to-book ratio and free cash flow.
However, the most important factor in determining a stock’s value is the business itself. A growing company is likely to see its stock rise in value; a shrinking company will not. A business with a defensible economic moat, large user bases and brand recognition, for example, will likely be in a position to retain customers even as competitors compete harder for their business.
A stock’s tax treatment depends on how long you hold the asset, and if you sell it within a year, you will be taxable at the short-term capital gains rate. If you hold the stock longer than a year, it will be taxed at the long-term capital gains rate.
In addition to buying stocks, a stock investor can also receive dividends that are paid out periodically to shareholders. Dividends are a return on investment that can help offset some of the volatility associated with stocks.
Some private companies that want to raise funds for growth and expansion will seek a public listing, or IPO, on the stock market through an investment bank. Once the IPO is sold, the investors who purchased the shares will be able to trade the stock on the NYSE or NASDAQ.
Some companies list on more than one exchange in order to reach a wider investor base. For example, large non-U.S companies can list on a U.S exchange and a foreign exchange to broaden the pool of potential investors. A company that lists on a foreign exchange must maintain a block of its shares at a holding bank in the United States, which issues American depositary receipts—or ADRs—for each share traders acquire. In the United States, there are several major holding banks.
