Stocks—also known as company shares or equities—are small slices of ownership in companies that are publicly traded on the stock market. As such, they’re a critical component of many investors’ plans to build wealth. Stocks offer the potential for higher growth than other types of investments, such as long-term savings accounts or bonds, but they can be risky and volatile.
The value of a stock depends on demand, supply, and other factors such as the economy and investor confidence. When demand for a stock increases due to favorable news, profit outlooks, or investor optimism, its price rises. Conversely, when current stockholders decide to sell shares, usually in response to disappointing news or economic uncertainty, the price of the stock falls. This constant flux is part of what’s known as the market process, in which buyers and sellers determine the fair value of stocks based on the information they have available.
Companies issue stocks to raise cash. This can help them pay off debt and fund growth plans that they can’t or don’t want to finance with new loans. Stockholders also get the opportunity to vote on decisions affecting the company and receive dividends, which are payments of a portion of a company’s profits. Share appreciation, or the increase in a stock’s value over time, can also be a source of income for shareholders.
A stock’s value is based on a combination of its earnings, revenues, and market capitalization (the total amount of all the company’s shares). Earnings tell analysts how much the company is bringing in each year, and revenue growth reflects how well the company’s products are selling to customers. However, a company’s profits can also decline for many reasons, including an unexpected loss or slowdown in sales.
In addition, a company’s financial history can affect its stock’s value, as can the industry it operates in. Generally, fast-growing companies are associated with higher risk because their stock prices can fall quickly if they miss profit estimates or lose investor favor.
Individuals can invest in stocks through a variety of investment accounts, such as brokerage accounts and retirement-saving accounts. For example, some employers offer their employees a 401(k), in which contributions are made with pre-tax money and taxes are deferred until the employee withdraws the funds at retirement. There are also mutual funds, which are pooled investments that seek to provide returns that match a given benchmark, such as the S&P 500 or a domestic or international index.