What are stocks?
To explain it simply, stocks are units of ownership in a company.
When you buy stock, you become a shareholder, which means you now own a “part” of the company.
If the company’s profits go up, you “share” in those profits.
If the company’s profits fall, so does the price of your stock.
What do you do with Stocks?
Stocks are a share of a company that can be purchased, held or traded by investors. In addition, you can vote on company matters and elections which we will discuss later!
When you buy a stock you are now considered an investor in that company and become a shareholder in a public company.
Again, this means that you have a small piece of ownership or equity in that company and can reap the financial gains from this ownership.
Equity is a common term used, and just remember it means ownership.
If a company offered 100 shares (stock) and you owned 75 of them, you would own 75% of the company’s equity.
Simple right? Let’s keep going!
Based on the company’s performance or other factors, the value of its stock may rise or fall, meaning that its shareholders either gain or lose money.
For example, if you purchased one stock of Apple for $100 and Apple’s stock price rose 10%, your stock is now worth $110.
Why do Companies offer Stocks?
Companies issue shares as a means to raise large amounts of capital, a.k.a money.
This capital is then used to fund different projects that will ultimately lead to growth and create a return for investors.
A company can go from private to public through the issuance of an initial public offering (IPO). When a company decides to go public, they must also choose 1-4 unique letters (depending on the exchange they are listed on) for unique identification (known as the stock ticker symbol).
Sometimes, companies can even get creative when it comes to choosing their ticker symbols.
Depending on the type of stock purchased, a shareholder can be entitled to vote.
Usually, one stock = one vote.
These votes are executed at the company’s annual shareholder meeting where issues are voted on.
The investment app M1 Finance, where I have my Roth IRA, you automatically receive email notifications to vote for the various companies in which you are a shareholder. Read more here!
These meetings include electing the board of directors, who oversee the management team of the company. Which is important! If a shareholder cannot attend the annual meeting to vote, he or she can vote by proxy by allowing another individual to vote in his or her name.
The company’s management team usually votes as a proxy for a large number of shareholders, because most shareholders, especially if they only own a few shares, do not attend the annual meeting.
This means that shareholders do not have to be involved in the daily affairs of running the company.
Dividends
Dividends as per the IRS definition is “regular income,” however, as someone building their passive income portfolio, dividends are the holy grail of passive income.
Passive income literally means earning money while doing nothing.
So what are dividends?
Some companies issue dividends to their shareholders, which are a part of the company’s earnings that are paid out to investors on a regular basis.
These payments are on top of any rise or decline in the value of the stock.
Dividends are typically paid to shareholders quarterly (four times per year), but companies may issue them annually, semi-annually or monthly. Monthly are the best!
Dividends may be issued as cash (most likely) or additional stocks (very unlikely) and may be fixed or variable.
Fixed dividends mean the percentage or dollar amount is the same each time dividends are issued, regardless of the company’s performance.
Variable dividends are tied to a company’s performance, meaning that dividend payments will be higher when a company has done well and lower when it hasn’t.
Companies can change their dividend policies at any time, even stopping dividends permanently or temporarily.
Dividends have many advantages; taxes, retirement account distributions, DRIPs, etc.
Classes of Stock
Companies can issue a variety of stocks based on the ownership rights a shareholder has. The two most frequent types are called common stocks and preferred stocks.
Most stocks issued are common stocks.
When an individual purchases a common stock of a company, they receive one vote per stock to vote on board members or decisions for the company.
This is different from preferred stocks, where the shareholder does not receive voting rights. Preferred stocks are a hybrid between common stock and bonds because as a holder, you’re paid a guaranteed dividend.
Common shareholders may or may not receive a dividend and if they do, it is normally a variable dividend.
Preferred shareholders must be paid their dividends before common shareholder’s dividends are distributed.
Variable and fixed dividends perform better in specific situations.
Example
Let’s say Jenny and Forest both have $100 of stocks in Starbucks, but Jenny has preferred stock and Forest has common stock.
The fixed dividend on Jenny’s stock is 5%.
Forest’s dividend depends on what Starbucks’ board of directors decide for a given quarter.
One quarter, Starbucks does extremely well and decides that the variable dividend will be 10%. Forest will receive $10 on his $100 in stocks, but Jenny will only receive $5.
Another quarter, Starbucks does very poorly and decides to issue a smaller variable dividend at 2%. Forest will only receive $2, but Jane will continue to receive $5.
This is an extreme example because most variable dividends are pretty consistent. Some companies known as the Dividend Aristocrats have been raising their dividend at LEAST once per year for the last 25 years or more!
Beyond common and preferred stocks, companies may choose to issue other types of stocks based on ownership rights of shareholders.
For example, Google issues Class A, Class B, and Class C shares. Class A shareholders receive one vote per share, Class B shareholders receive 10 votes per share and Class C shareholders receive no voting rights.
This type of structure is used to control the voting power of the company. In Google’s case, the Class B shares are not available on the public markets but are instead owned by management within the company.
Stock Market Indexes
Stock market indexes track the value of a large number of stocks.
One of the best-known indexes is the Dow Jones Industrial Average. The Dow Jones measures the value of 30 stocks from large, reputable companies, sometimes referred to as blue-chip stocks.
Another well-known index is the Standard and Poor’s 500 (S&P 500), which follows stocks from the 500 largest companies. Think Google, Amazon, Apple, etc.
Stock market indexes can serve as a benchmark for the performance of specific investments. Meaning an investor who purchases stock in a company could monitor its performance by comparing it to the S&P 500 to see if it has performed well historically.
The indexes are also used to describe how the overall market is performing. You’ll hear the specific amount of points the Dow Jones or S&P have gained or dipped for the day.
How to Buy Stocks
Stocks can be purchased in a variety of ways, including;
- through a broker
- as part of a mutual fund or exchange-traded fund (ETF)
- as part of a dividend reinvestment plan
- directly from the company issuing the stocks
The most common is purchasing stocks through a brokerage, either by buying the stock itself or buying a mutual fund or ETF.
Mutual funds and ETFs focus on sectors, such as blue-chip stocks, or may include securities such as bonds.
When purchasing stocks from a brokerage, there are commissions and transaction fees. However, Robinhood and M1 Finance — my two favorites — are FREE.
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Investors have the option to purchase stocks directly from the company. This is known as a direct stock purchase plan. Not all companies do this and most only allow their employees this option.
Finally, investors may also purchase shares of a company through a dividend reinvestment plan (DRIP). This plan allows investors to automatically reinvest any dividends they receive to buy more stocks.
Conclusion
Investing is a journey.
It’s fun, but can be scary.
Make sure to follow the 10 Most Important Things You Must Do Before You Invest.
Remember, there are always more lessons to be learned, strategies to discover and money to be made.
Buying stocks is not a gamble but an investment. It is not a pastime but a commitment. To be truly successful, hard work and dedication are crucial. The stock market encompasses a world where patience is rewarded and composure breeds success.
Qualities like discipline, emotional control, persistence, and focus will flourish as investing experience.
But above all, a commitment to learned-investing breads a lifetime of improved finances.
Below is a short video from Investopedia on “What Are Stocks?”
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