While stocks aren’t without risk, they offer a potentially great way to grow your savings and help you achieve your financial goals. If you invest in a broad range of stocks over the long term, history shows that you’ll likely earn positive returns on your investment. However, if you buy and sell shares at the wrong time, you could lose money. That’s why it’s important to understand how to evaluate a stock’s performance and make smart decisions about when to buy and sell.
Stocks represent ownership of a company’s assets, earnings and other benefits, including dividend payments (if the company pays them) and capital appreciation—the increase in the value of the share over time. The value of a share is determined by the supply and demand for it in the market, which is influenced by a variety of factors such as economic trends, political events and investor sentiments.
When a company wants to raise funds to grow its business, it issues shares of stock in a process known as an initial public offering (IPO). Then, the stock is traded on the market, where investors can buy and sell it. Companies issue different classes of stock, with each type having specific voting rights and a purpose. For example, the holding company Alphabet has three types of stock: Class A shares, which get one vote per share; class B shares, which get 10 votes per share and allow founders and executives to retain a significant amount of control; and class C shares, which don’t vote at all and are primarily used for employee retirement plans.
The best approach to evaluating a stock is to compare its performance against a benchmark and to assess its intrinsic value. The benchmark is the broader market, and it’s important to remember that not all stocks are created equal. It’s also critical to weigh a stock’s return in relation to its industry. You should never be satisfied with a stock’s performance if it’s not beating the market, or even its own industry.
There are many ways to analyze a stock, and it’s not always easy. One method is to use the price-to-earnings ratio, which measures how much investors are willing to pay for a dollar of a company’s earnings. Another popular approach is technical analysis, which focuses on how a stock behaves in the market and how it’s being influenced by other investors. This includes assessing its momentum, which refers to how quickly it rises or falls; the relative volume of trading, which indicates how many buyers and sellers are involved; and chart patterns like trading within a range or crossing a key level. A more in-depth approach to valuation is known as discounted cash flow analysis, which requires estimating all of a company’s future cash flows. But that’s a lot of work, and it isn’t always necessary for most investors.
