A stock is a share of ownership in a public company that you can buy and sell on the stock market. The value of a stock fluctuates as demand and supply changes on any given day, but over the long term it will be determined by how successful a company has been in its business operations. When a company is growing sales and profits, its stock will rise; when it is losing money or fading in popularity, its stock will fall.
A company may issue stocks to raise capital, pay off debt, launch new products or expand its business operations. The type of stock (common or preferred) held by a shareholder determines the rights and benefits of ownership. If the company goes bankrupt, a common shareholder can lose only the value of his or her shares; however, if he or she owns preferred shares, they have priority over common shareholders to receive dividends and liquidation proceeds.
Most investors, including those in retirement savings accounts such as 401(k) plans, invest in companies’ stock through mutual funds or other pooled investments. These funds typically track a particular index or group of stocks to maximize diversification and minimize investment risk. If you’re interested in investing directly in individual stocks, many of the same rules apply as with mutual funds, but you have to do the legwork yourself.
Many people are drawn to the stock market as a way to grow their wealth and outpace inflation over time, but it’s important to keep in mind that the stock market can be very volatile. As a result, you’ll likely experience losses from time to time and may even become totally wiped out if the market crashes. You’ll need to steel yourself to be patient and focus on the long-term, not short-term gains or losses.
There are many ways to assess a stock’s value, from quantitative metrics like price-to-earnings and PEG ratios to qualitative considerations such as a defensible economic moat or strong user base, among other factors. Some investors also consider the effect of taxes, which can add or subtract significant amounts from a stock’s total return over time.
The key to being a successful investor is understanding the difference between “fair” and “overpriced” values. The latter can be hard to identify, especially when a company has a hot new product that’s getting a lot of attention and excitement from investors. This can lead them to leap into a stock without properly assessing the potential for profit, or believing that it’s impossible for the market to “miss out.”
To avoid investing emotionally, you’ll need to understand what makes a good company and how its stock will be affected by the economy and other markets. You’ll also need to separate yourself from the daily news cycle and invest based on sound research and fundamental analysis. And if you’re thinking of buying a stock, be sure to check out five key ratios that can help you determine its true worth.
