A stock is a financial security that represents ownership – or equity – in a company. Owners are called shareholders and they have a proportional claim on the company’s net assets and future earnings. Most stocks are publicly traded and trade on regulated exchanges like the New York Stock Exchange and Nasdaq. Private companies may also sell shares, but these securities are generally illiquid and volatile and only accessible to very wealthy or highly accredited investors.
A successful stock investment is based on business results, which are in turn driven by the overall economy and, to a lesser extent, interest rates. During long periods of time, stock prices closely track corporate profit growth. When a company reports profits that exceed expectations, the stock market typically rewards this performance with higher prices. A successful company will likely have products or services that are in demand and talented, experienced managers running the business.
Choosing the right stocks for a portfolio takes time and thought. There are many questions to ask and well-established methods for evaluating the merits of individual stocks. Some important issues include how the company makes money, whether its products and services are in demand, and how much debt it has. Other factors include how the stock performs relative to other stocks in its industry and its historical returns.
Investors also consider dividends and inflation when assessing a stock. Dividends are payments made to shareholders of a company, usually on a regular basis. Increasing dividend payments may help offset the impact of inflation, which can erode the value of a stock. Inflation can also eat into the real return on an investment, so careful investors make adjustments for expected inflation in their returns calculations.
In addition to considering these and other financial factors, investors evaluate the quality of management at a company and its history of growth and profitability. A stock with a proven record of strong returns can provide solid, steady gains for the long term. But, over time, even the best stock can lose value if it is not performing in line with its industry and the broader market. This is why it’s important for investors to diversify their portfolios with both long-term and short-term investments. This helps them to mitigate the risk of losing a substantial amount of their wealth in one particular area.
