What Are Stocks and Should You Buy Them?

Whenever someone talks about getting rich or saving for retirement, stocks and bonds often enter into the conversation. You may have overheard a conversation about someone making it big in the stock market and may not be totally sure what that means. Well fear not! I will attempt to break down the basics of stock ownership so that you can determine if investing in stocks is something that is right for you.

Why Do Companies Sell Stocks?

Let’s say you’ve started a company selling widgets and things have been going fairly well for you. You have a decent amount of customers but there are opportunities to capture even more customers. The only thing is, you need a large sum of money. Right now, you are what we call a private company, meaning the ownership of your company is not traded publicly. However, in order to get that large sum of money, you have decided to take your company public, which means that you will be trading ownership of your company by selling stocks in the general public.

From this point, you will hire an investment bank to buy a portion of your company and sell the shares of that portion in the market place where investors like me can buy small pieces of your business. Your company gets that major cash infusion from the investment bank and I get to own a small percentage of your business which gives me the right to share in your profits. Everyone wins!

Common Stock

The most basic form of “equity” or “ownership” of a company comes in the form of common stock. Common stock can be bought and sold easily today. You can buy common stock online or with a broker without breaking a sweat. If you want to own a piece of company, then you buy shares of that company. Each share is worth a fraction of the company. If the company has 1,000 shares and you own 100 of them, then you own 10% of that company. Easy concept right?

As an owner of common stock, you are entitled to certain rights and privileges. You have the right to vote for any major issues that affect your status as a proportional owner of the corporation. These issues are usually stock splits, mergers, acquisitions, board elections, and changes of business objectives. Your votes are directly related to the amount of shares you own. If you own 100 shares of stock, then you have 100 votes to cast. However, shareholders never get to vote on rather or not a corporation issues dividends.

In addition to voting rights, as a shareholder (meaning you own stock in the company), you have the right inspect the corporation’s financials through quarterly (10Q) and annual (10K) reports. Inspecting financial data gives you an opportunity to see how your company is spending and making money. If your company goes bankrupt, as a stockholder you will be in line to receive money gained after the sell of that company’s assets. However, owners of common stock are last in line behind creditors, bondholders, and preferred stock holders. Note: A college professor reminded me that the people who really get paid first are always the lawyers

Dividends

Now that you own stock in a big corporation, you can enjoy the privileges of being an owner. The greatest benefit of all is that you get to share in the profits. After all, the only reason you’re investing in the first place is to make money! So if your company has a good year financially, the Board of Directors have the power to decided to pay a dividend to stockholders.

Simply stated, a dividend is money received from profits that is shared amongst shareholders. If a $.10 dividend per stock is declared by the company, the 100 shares of stock that you owned have just made you $1.00. As you accumulate more and more stock, those dividend payments can really add up. However, companies can also elect to pay dividends in stock. When this happens, you will receive extra shares of the company as payment instead of cash.

So How do People Make it Big In The Stock Market?

The same way you make money doing anything else. Buy low, sell high. Think of stocks as being something similar to real estate. In real estate, people look to make money by buying a home at one price and selling it down the road at a higher price for a profit. Stocks work something like that.

Let’s say that the company that went public at the beginning of this article started selling shares at $1.00 per share. As time went on the company became bigger, stronger, and more profitable. As a result, the demand for shares of their company has increased. When the demand of anything increases, it’s price will increase as well.

So a few years later, the market price for the company has risen to $20.00 per share. That’s a jump of 2,000% or $19.00 per share. Your $100 investment that gave you 100 shares in the beginning is now worth (100 x $20) $2,000. It’s that simple.

Buying stock and waiting for them to appreciate in value is the most common way that people make money in the stock market. There are a ton of other ways to invest but they require an in depth knowledge of markets and financial instruments. Understanding the basics is the best way to go before you get involved with options trading or any other strategy.

I hope this brief explanation of stocks helps! Now is always a good time to invest. Just remember, buy low and sell high. Also, Warren Buffet would caution you to never buy stock in a company that you don’t want to own for at least 5 years. The conservative approach is to buy and hold for the long term. As fast as you make money in this market, you can also lose it. Invest wisely and God bless.

Resources

Sharebuilder – Build an online account to invest regularly for only $4 per trade

Motley Fool – Provides practical investing advice

Wall Street Journal – The “Bible” of the Financial World

Up Down – A website that allows you to use fake money to invest in real stocks. Depending on how good you are, you can actually win cash prizes. Great for practice if you’re not comfortable doing the real thing.