What is a Stock?
A stock, also known as equity, is a type of security representing ownership in a corporation.
Ownership of the company is split up into potentially millions of pieces and investors can buy the pieces. Each piece is called a share, or stock. The proportion of how much an investor owns is measured through these units of stock. How many pieces each company has depends on the individual company.
For example, if a company issues 10,000,000 shares and an investor buys 1,000 shares they own 0.01% of the company.
How to Make Money with Stocks
The two main methods of making money with stocks are when investors profit off a corporation's increase in their market value and through companies that pay stock dividends.
When the market value of a stock rises, investors can profit off this increase when selling the stock. In other words, making money with capital appreciation is taking advantage of the difference between the investor's purchase and selling price of a stock.
For instance, if you purchase a share at $50 per share and it goes up to $55, you will earn $5 in capital appreciation if you were to sell.
Investors can purchase publicly-listed stocks where companies distribute dividends to their shareholders. Dividends are paid out of company profits, at the expense of reinvesting back into the business.
Dividends aren't all of a company's profits since it'll keep some of it towards business growth or operations. A company's board of directors will ultimately decide how much to set aside in their earnings to reward its investors for investing money into their business.
In most cases, dividends are paid out in cash, though some pay out in additional stocks.
Common vs Preferred Stocks
Both types of stocks help the investor to earn money, though the main difference lies in voting rights. Common stocks tend to allow shareholders to receive dividends and vote at shareholder meetings. Preferred stocks, on the other hand, don't have voting rights but will have more of a claim on a company's assets and earnings compared to common stockholders.
For instance, if a company goes bankrupt, preferred stock owners will be repaid their principal before common shareholders do.
How Do You Buy Stocks?
Investors can purchase stocks on stock exchanges such as the New York Stock Exchange (NYSE) and the NASDAQ. Most individual investors will purchase publicly-traded stocks, which is what happens after a corporation places their stock on an initial public offering (IPO).
In most cases, investors will purchase stocks through the exchange using their brokerage account.
Types of Stocks
There are many different types of stocks out there, with the most popular types generally falling under these three categories: growth, value, and blue-chip stocks.
Growth stocks have a higher price to earnings ratio and don't generally pay significant dividends. They can also offer higher returns, but come at the cost of higher volatility, or risk levels. Companies that have strong and increasing demand in the market tend to have the most successful growth stocks. This is especially so if the company can tap into customer needs for the long haul.
That being said, these businesses can face a lot of competition -- the chances of a growth stock's business being disrupted can be high. Even a slow period in the business can be the cause for lower stock prices.
Examples of growth stocks include Amazon and Facebook.
Value stocks are the opposite of growth stocks because they tend to be undervalued, trading at a lower price compared to a company's earnings, cash flow and overall book value. Companies offering value stocks tend to be well-known and have been around for a long time. They may have also proven themselves -- aka are known as leaders in the industry.
Investors who desire stability in their investments can choose businesses that have reliable models that have proven to work. Though returns may not be as high, value stocks are usually more mature companies which pay higher dividends.
Examples of value stocks include JPMorgan Chase and Intel.
Blue chip stocks are issued by companies who have excellent reputations and are revered by their industry. They're similar to value stocks in that they provide stable returns.
Examples of blue-chip stocks include Unilever and AT&T.