A stock is a share in the ownership of a company and, depending on the type, can also grant shareholders voting rights. Many people own shares in one company or another, either individually or through an employer-sponsored retirement account, such as a 401(k). As a long-term investment, stocks can help grow wealth and outpace inflation. However, the market fluctuates, and investors sometimes lose money when they sell their shares.
Unlike other investments, stocks represent partial ownership of a company and a claim on the assets and earnings of that company. The stockholders’ share of the company’s profits are called dividends.
In addition to dividends, investors can also make money when stocks rise in price and get sold for more than they paid for them. This is known as a capital gain. In contrast, if you buy a stock and it falls in value, this is known as a capital loss.
Investors can measure a stock’s fair value using relative or absolute valuation methods. Relative measures include ratios like price-to-earnings (P/E) and price-to-book value, which compare a stock’s performance with other stocks or market indexes. Alternatively, investors can look at qualitative characteristics of a stock, such as a sustainable competitive advantage or strong brand.
A stock’s fair value can be influenced by economic conditions, which can affect interest rates and consumer spending. For example, if the economy slows, stocks in consumer discretionary and technology industries may decline because consumers will spend less on these areas. Conversely, consumer staples and utilities stocks may perform better in a weak economy because consumers must keep buying these products.
A stock’s fair value can also be influenced by the company’s debt levels and financial health. High debt can increase risk and reduce a stock’s fair value. Conversely, if a company is not growing fast enough to justify a high P/E, it may need to take on more debt to increase its growth opportunities.
