Stocks, company shares or equities are one of the core tools that many investors use to grow their savings and help them plan for long-term financial goals. But they’re not without risk, as stocks can lose value as easily as they can rise. Understanding how and why stocks can move so dramatically in the short term can help you make smart decisions about how much to include them in your portfolio.
Stocks are an important piece of any investment portfolio because they give you fractional ownership stakes in publicly traded companies. While there’s no guarantee that stocks will rise in value, they’re often more likely to grow over time than other investments like bonds, which typically operate more like a loan to the company. And as a bonus, most public companies offer the opportunity to receive dividend payments from their earnings, which can be used to increase your overall return.
A share of stock represents part-ownership of a publicly traded company, and it can be bought or sold on a public exchange. Investors can buy individual stocks through a brokerage account, or they can invest in exchange-traded funds (ETFs), which are pre-arranged “baskets” of companies that can reduce fees and provide diversification within their accounts.
The basic law of supply and demand tends to drive stock prices in the short term, with more buyers than sellers causing prices to go up and vice versa. But other factors can also influence them, from the economy to the latest news about a specific company or industry trend.
There are two basic types of stocks: common and preferred. The former come with voting rights that allow stockholders to vote on issues like management elections or structural changes in a business. They can also benefit from tax advantages, as they’re generally viewed as more “liquid” than other types of investments such as bonds.
Preferred stocks, on the other hand, don’t come with voting rights, but they are given “preferred” status in that their earnings are paid out before those of common stockholders. This can make them less volatile, but it also means that they’re not as liquid if the company goes under and needs to sell off assets to pay back investors.
While it’s impossible to know exactly what a particular company’s shares are really worth, you can determine their intrinsic value by using different methods of valuation. Some of the more popular ones are comparing the price-to-earnings ratio of a stock against its peers, or using a valuation tool that compares a stock’s revenue, net income, profit and book value to calculate an intrinsic value. But no method of valuation should be used alone, as it’s not always possible to factor in all the information that might affect a company. Even the best valuation tools can miss things like future technological advances, changes in consumer preference or economic conditions. That’s why it’s important to use them in conjunction with a well-thought-out investment plan that reflects your investing goals and the level of risk you’re comfortable taking.