Up and Dow: Stock Market Basics
To the average person, stocks are something of an enigma; something you buy, sell, and hopefully make money on. They represent an investment. Right now, investing in the stock market is looking more tantalizing than ever. With the Dow Jones Industrial Standard hitting 21,000 for the first time in its history today, it's a great time to brush up on your stock knowledge, and good news! We here at Strategic Advisory Services want to help you out. Here are a few basic things to know about stocks:
Why invest in stocks?
The main reason that investors buy stock is to seek capital appreciation and growth. Although past performance is no guarantee of future results, stocks have historically provided a higher average annual rate of return over long periods of time than other investments, including bonds and cash alternatives. Correspondingly, though, stocks are generally considered to have more volatility than bonds or cash alternatives.
Can you lose money?
Yes, you can. There are no assurances that a stock will increase in value. Several factors can affect the value of your stocks:
Actions of investors: If a large number of investors believe that the nation is entering a recession, their actions can affect the direction of the stock market
Business conditions: A new patent, an increase in profits, a pending merger, or litigation could affect investor interest and stock prices
Economic conditions: Employment, inflation, inventory, and consumer spending influence the potential profit of a company and its stock price
Government actions: Decisions on interest rates, taxes, trade policy, antitrust litigation, and the budget impact stock prices
Global economy: Changes in foreign exchange rates, tariffs, or diplomatic relations can cause stocks to go up or down
All investing involves risks, and there can be no assurance that any investing strategy will be successful. However, understanding these factors can help you make sound investment decisions and keep losses to a minimum.
What are the different classifications of stocks?
Stocks are often classified in the following ways:
Growth stocks have earnings that are increasing at a faster rate than the market average. These are usually in new or fast-growing industries and have the potential to give shareholders returns greater than those offered by the stocks of companies in older, more established industries. Growth stocks are the most volatile class of stock, however, and may be just as likely to go down in price.
Value stocks are those of companies with good earnings and growth potential that are currently selling at a low price relative to their intrinsic value. Due to some problem that may be only temporary in nature, investors are ignoring these stocks. Since it can take quite some time for their true value to be reflected by their price, value stocks are usually purchased for the long term.
Income stocks are generally not expected to appreciate greatly in share price, but typically pay steady dividends. Utilities are an example of companies that have historically been considered income-oriented.
Blue chip stocks are the stocks of large, well-known companies with good reputations and strong records of profit growth. They also generally pay dividends.
Penny stocks are very risky speculative stocks issued by companies with short or erratic performance histories. These stocks are so named because they sell for under $5 per share. Their low price appeals to investors willing to assume a total loss in exchange for the potential for explosive growth.
It is usually best to diversify among the different classifications and not own stock in just one or two companies or industries (though diversification alone cannot guarantee a profit or ensure against a loss).
How are stocks bought and sold?
During an initial public offering (IPO), new issues of stock are sold on the basis of a prospectus (a document that gives details about a company's operation) that is distributed to interested parties. Investment bankers or brokerage houses buy large quantities of the stock from the company and sell them to investors. After the IPO, the stock may trade on a stock exchange or over the counter.
Normally, stock is purchased through a brokerage account. The buy order you place will be directed to the appropriate stock exchange. When someone who owns the stock is willing to sell at the price you are willing to pay, the sale takes place. A commission or fee is charged on your transaction.
Stock certificates may be transferred from one owner to another since they are negotiable instruments. The certificates are issued in the buyer's name or, more typically, held by the brokerage house in street name (i.e., the brokerage firm's name) on behalf of the investor. The advantage of a street-name registration is that if you decide to sell, you do not have to sign and deliver the stock certificates before the sale can be completed. And you don't have to worry about losing the stock certificates.
Some stock investors have made money quickly. But they are the exception rather than the rule. Investing in stocks requires a long-term outlook. Read books, attend seminars, and take advantage of professional advice. Education, good judgment, common sense, and above all, patience increase your chances of achieving your goals.
If you have any other questions or clarifications about stocks, bonds, or other areas of wealth management, don't hesitate to give us a call!