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What does stock mean?
What is the difference between a stock and a share?
What is the difference between common stock and preferred stock?
What is the difference between a stock and a bond?
Why do companies issue stock?
You may understand that stocks trade on a market and go up and down based on the fortunes of an existing business. But do you understand exactly what a stock is and how it works?
Let's go over how stocks work and what different types of stocks there are.
When you own stocks, you own a part of a business. This technically means you have a claim on the business's assets if it goes bankrupt.
Over the long run, you'll make money from stocks if the business continues to grow and make money. You can also make money off stocks when share prices increase or when the board of directors declares a dividend payment. The best stock investors are the ones who recognize that picking stocks is about buying good and growing businesses.
You can buy and sell stocks using a brokerage account. When you want to buy a stock, the broker (or a computer the broker owns) buys the stock and records the transaction for your account. In most accounts, you just type the stock ticker symbol in on the broker's website or app and tell it how many shares you want to purchase.
Owning a stock gives you certain rights, and those rights can differ depending on the type of stock you own.
The reason so many people invest in stocks is that if a business is successful, its stock will usually rise in price in the long run.
It's important to understand that this won't always be true, especially over shorter periods of time. Stock prices are subject to regular market forces such as supply and demand that don't always match up with the fundamental health of the underlying business.
Benjamin Graham, one of the most famous investors in history, said: "In the short run, the stock market is a voting machine but in the long run, the stock market is a weighing machine."
Few other investments offer the return potential of stocks. Bonds offer predictable fixed interest payments of interest repayment of principal. But, even if a company does well, bondholders typically don't see the value of their holdings grow. Real estate has more growth potential than bonds, but historically it hasn't grown at the same rate as stocks.
Stock investing can seem intimidating, but the basics of what a stock is aren't too hard to understand. By focusing on the ownership element of investing in stock, you'll be better able to choose companies to invest in that will help you reach your financial goals.
A great place to start learning about stocks and eventually buy a few is with your favorite products. However, it's important to learn how to value a stock by analyzing a business and its financials.
There are all kinds of ways to start investing in stocks. If your employer offers a 401(k) plan, you can use that to pick mutual funds that will buy stocks and, in some cases, pick your own stocks. If it doesn't, consider opening an individual retirement account (IRA) or a brokerage account to start buying stocks.
You should only start to buy stocks if you're in a good place financially. In the short-term, stocks can be volatile, so don't put your savings at risk unless you've paid down high-interest debt and have cash set aside for a rainy day.
A stock represents an ownership interest in a business. When a business wants to raise money, its board of directors determines the number of shares to issue.
When the business goes public, its shares start trading on the stock market. In the U.S., businesses trade on stock exchanges such as the Nasdaq or the New York Stock Exchange (NYSE). Individuals and institutions can buy and sell shares of publicly traded stocks.
Let's use Netflix (NFLX +14.03%) as an example of stock ownership. Netflix went public in 2002, and, since then, investors have been able to own a fractional portion of the company in their investment accounts.
When Netflix wants to raise more money, it issues more shares for investors to purchase. Since owning stock is owning a piece of the business, as Netflix's business did well and earned more money, the stock's price skyrocketed.
Companies with extremely small market capitalizations and low share prices often trade on over-the-counter (OTC) markets and are listed on the pink sheets. Many of the stocks that trade on OTC markets are known as penny stocks.
