Stocks: What Are They and What Do You Need to Know About Them?

Buying stocks is a form of investment that gives you a share of ownership in a publicly-traded company.

The Meaning of Stocks, Along with an Example

The purchase of stocks denotes the ownership stake in a publicly-traded company. When you purchase stock in a company, you automatically become a part-owner of that business. For example, if a company were to have 100,000 shares and you buy 1,000 of them, then you own one percent of the company. Another way to look at it is this: When you own stocks in a company, you have voting rights as a shareholder and the ability to profit more from the growth of the company. Shares and equity are two other names for the same thing.

Key Takeaways

The stock represents the ownership stake in a company.
A rise in a stock's share price and the receipt of dividend payments are the two primary avenues to financial gain from ownership of that stock.
One way to classify stocks is according to their sector, value, or valuation.

Stock Markets –– How Do They Work?

Businesses often sell shares of stock in order to raise additional capital, which can then be used to expand the company, introduce new products, or pay off existing debt. The "initial public offering" refers to the very first time a company makes its stocks available to the general public (IPO). After the initial public offering (IPO), shareholders will be able to resell their shares on the stock market, which is a marketplace where prices are determined by supply and demand. The price will go down when there is a greater quantity of stock available for purchase. The price of a stock will go up proportionally to the number of people who buy it. A company's anticipation of future earnings or profits is the primary motivation for stock purchases and sales. Traders will bid up the price of a company's stock if they believe the company's earnings are already high or will continue to rise in the future. The sale of shares at a higher price than the one at which an individual originally purchased them is one way for shareholders to generate a return on their investment in the company. When you sell your investment, you risk losing some or all of it if the company you have invested in does poorly and its shares decline in value. The term "capital gains" refers to the revenue earned from the sale of an investment such as a stock. Another method by which shareholders can profit is through the receipt of dividends. These are payments that are made on a quarterly basis and are calculated on a per-share basis out of a company's earnings. It is a way to reward stockholders, who are the actual owners of the company, for investing, as well as a way to share earnings with stockholders. Companies that are profitable but do not experience exponential growth for one of the following reasons are especially well-suited to pay dividends:

Being in a stage of the company's lifecycle that one can describe as mature or stable
The sector of the economy in which they are active (for instance, utilities versus technology)

Blue-chip stocks and value stocks are two common names for well-known stocks that pay dividends. Investing in derivatives is the third and most high-risk method for making money off of stocks. Derivatives get their value from the underlying assets they are based on, such as stocks and bonds. You have the choice to either buy or sell a particular stock at a predetermined price before a certain date if you have stock options. The right to buy at a predetermined price is referred to as a call option. You will generate a profit if you buy the stock at the lower fixed price and then sell it at the current market price when the stock's price increases. The right to sell an asset at a price that was predetermined is known as a put option. When the price of the stock goes down, you will make money. In this scenario, you buy it at the lower price that will be available the following day and then sell it at the higher price that was previously agreed upon. The majority of financial planners will tell you that the best way to achieve the highest return with the least amount of risk is to stick to buying and holding stocks for the long term within a diversified portfolio.

Stocks –– The Two Main Categories

The most common kinds of stocks are called common and preferred, respectively.

Common Stocks

Both the Dow Jones Industrial Average and the S&P 500 are used to monitor the performance of common stocks. When they are traded can have a significant impact on their values. Owners of common stock have the right to vote on important issues affecting a corporation, including the election of directors, mergers and acquisitions, and takeovers. However, if a company declares bankruptcy and liquidates its assets, the owners of common stock will receive the least amount of money from the sale of the company's assets. This is because common stock owners are paid out after bondholders and preferred stockholders.

Preferred Stock

Preferred stocks are another form of ownership in a company; however, they do not confer voting rights on their holders. As a result of the fixed nature of the dividend payments, holders are aware of the actual rate of return that can be anticipated on dividends. There is the potential to convert preferred stocks into another type of ownership.

Stocks –– The Other Types

There are additional ways to classify stocks and the fundamental categories that have been discussed.

Stock Industry Sectors

The various organizational structures accommodate the various requirements of shareholders. You can also divide stocks into different categories according to the characteristics of the companies that issued them. The following types of stocks can be categorized according to their industry sector:

Companies that extract natural resources are called basic material companies.
Conglomerates are multinational corporations that operate in multiple industries.
Companies that provide goods for retail sale to the general public are considered to be providers of consumer goods.
Banks, insurance companies, and real estate businesses are included in the financial sector.
The healthcare sector includes health insurance providers, manufacturers and distributors of medical equipment, and pharmaceutical companies.
Manufacturing companies produce industrial goods.
Services are provided by businesses that ensure customers receive their purchases.
In the realm of technology, we have computers and software.
Companies that provide essential services, such as water, gas, and electricity, are in the utilities industry.

Growth Stocks

One more way to categorize stocks is according to their potential and value. These are typically younger companies with a great deal of room for their business to expand and for new additions to their model. There is an expectation that growth stocks will experience rapid growth; however, growth stocks typically do not pay dividends. There are times when companies may not even be making a profit yet, but investors still have faith that the stock price will go up.

Value Stocks

A company is considered to have a value stock when its stock is trading at a price lower than its fundamentals, which can include dividends and other metrics or multiples. It is not expected that there will be a significant increase in the price of the stock itself. These are typically very large corporations that have been around for a while, so the market pays them no attention. Intelligent investors believe that the prices are too low in relation to the companies' value.

Blue-chip stocks

Blue-chip stocks are fairly valued and may not experience rapid growth; however, the underlying companies have demonstrated that they are reliable and operate in stable industries over the years. They are investments that are considered to be safer than growth or value stocks because they pay dividends. They are also referred to as "income stocks" on occasion.