A stock is an ownership share in a public company, granting investors voting rights and sometimes the ability to receive dividends. Investing in stocks generally provides capital appreciation over time, but there are no guarantees, as the stock market’s volatility can lead to large losses. To mitigate this risk, prudent investors keep their investment horizon long and seek to diversify across many companies and industries.
When companies go public, they typically issue shares of stock to the public through an initial public offering (IPO). Then, their stocks are traded on a marketplace like the New York Stock Exchange or Nasdaq. Investors can open a brokerage account to buy and sell these shares, essentially becoming a part owner of the company. A share’s value can rise or fall depending on a number of factors, including the company itself as well as global events such as the COVID-19 pandemic and interest rate hikes.
In general, companies sell stock to raise funds and help finance growth plans that they cannot — or don’t want to — finance through debt. Over the long haul, stocks have historically provided higher returns than other investments, such as savings accounts or real estate. However, they also have the potential to decline substantially in value over shorter periods, as was the case during the Great Recession and the early days of the COVID-19 pandemic.
The value of a stock is defined by two things: its fair value, which is based on a company’s fundamentals, and its market price, which reflects what people are currently willing to pay for it. In some cases, a company’s fair value is much higher than its market price, which can make it a more desirable investment.
A company’s value can also change when new shares are issued, as this dilutes the ownership and rights of existing shareholders. A company may also buy back its own shares, which can also reduce the number of shares in circulation and potentially raise their price.
Most individual stocks do not pay dividends, but some, especially large, publicly-traded companies, do. These dividends are the money that investors receive once a year for owning shares of the company, and they can supplement an investment portfolio’s income. Investors with more conservative financial goals often choose to generate income through dividends rather than from price appreciation.
It’s important to note that the historical return on stocks is an average — and that not all individual companies or sectors have been winners. As such, careful investors build diversified portfolios that include a mix of assets to maximize the chance of achieving their financial goals over the long term.