When we talk about investing in stocks, what does it really mean and how does it all work? You’ve probably heard about the stock market and wondered how do I become an investor. Before investing in any type of product, I suggest you do your homework and understand how that investment works. Today’s post will cover some of the basics of stocks that will help you understand more about the stock market.
1) What is a share of stock? – A share of stock represents ownership in a company. Corporations that sell stock are selling part of the equity of the company. One reason a company may choose to issue stock is to raise large sums of capital that does not have to be repaid. By issuing stock (equity), the company will not have to repay a loan. Companies may use a stock issue to pay off another debt, expand their business, purchase another business, launch a new product or product line, etc.
2) What are the different types of stocks? Generally, there are two main types of stocks, common and preferred. Common stock has the benefit of allowing the owner to vote at shareholder or stockholder meetings and to receive dividends if the stock pays dividends. Preferred stock usually has no voting rights, but will receive dividend payments before common stockholders will. For example, if a company pays dividends to preferred and common stockholders, but does not have enough to cover paying everyone, the preferred stockholders would be paid first and any remaining dividend amounts would be paid to common stockholders.
3) What are the categories of stocks that you can invest in?
- Growth stock – Stocks whose earnings grow faster than the market average. Growth stocks do not normally pay a dividend. Investors invest in growth stocks in hopes the stock price will appreciate or increase in value.
- Income stock –Stocks that pay dividends to stockholders. Many people invest in income stocks for the dividend income. Dividends are generally paid quarterly. Companies can either send you a check for your dividends, deposit the dividend in your investment account, or can invest the dividend in purchasing more shares of the stock for you. The last option is called dividend reinvestment. Instead of receiving cash, you would receive a certain amount of stocks. To illustrate how dividend reinvestment works, we will assume that a stockholder will receive a $15 dividend. Under dividend reinvestment, the $15 would go towards purchasing stock. Let’s say the stock price is currently $9.25 per share. To calculate how many shares you would receive, take the $15 and divide it by $9.25 which would equal 1.622 shares of stock.
- Value stock – Stocks that have a low Price to Earnings Ratio (P/E ratio). In this case, values stocks are less expensive than stocks with a higher P/E ratio. Some value stock investors buy the stock in anticipation that the stock price will go back up.
- Blue-chip stock – These stocks are companies that have a solid growth history and they usually pay a dividend to stockholders.
To research information on stocks, go to finance.yahoo.com. On the left-hand side of the page, you should see a box that says “Quote lookup.” This is where you would type in the symbol of the company you want to view. Just as an example, type in NKE for Nike and take a look at the stock information. As of the time I checked NKE, the stock was trading for $54.36 per share. Next week’s blog post will be a continuation of the discussion on stocks.