Stocks are a cornerstone of many investors’ portfolios. When you buy stocks, you own a piece of a company, and that share can increase in value as the company does well and grows. Stocks can also offer higher returns than other assets such as bonds or cash. However, they’re more volatile, and it is possible to lose money on a stock investment. For that reason, stocks are best suited for investors who want to grow their investments in line with economic growth and can tolerate volatility.
Publicly traded stock is what most people think of when they hear “stocks.” These are the shares that can be purchased through brokerages and investment apps and may be seen on news reports. Companies can also issue private stock to raise funds for business operations or expansion. Private stock may be a little more volatile than publicly-traded stocks, but can still offer outsized returns when compared to other asset classes.
When a company offers its first stock to the public, it is called an initial public offering (IPO). Companies work with investment bankers to set a price at which they’ll start trading on primary markets. This price is based on valuation and demand from institutional investors. Stocks then trade on secondary markets, where prices fluctuate based on supply and demand. The underlying principle is that, on a second-by-second basis, the price of a stock reflects the sum of what current buyers are willing to pay and what current sellers are willing to accept. It’s like a voting machine, where the current buyers and sellers are constantly changing their votes.
In addition to the potential for share appreciation, the company’s underlying business can provide an additional source of return in the form of dividends. Dividends are the distribution of a portion of a company’s profits to shareholders. They’re usually paid out once a year, and are taxed at the same rate as other income.
The reason to invest in stocks is their history of providing high returns. While nothing is guaranteed, stocks have typically outperformed lower-risk investments such as bonds and cash over the long term.
Investors can group stocks by size, industry, or style. Small-cap and mid-cap stocks tend to be more volatile than large-cap stocks, but can also have outsized returns. Some investors may prefer to focus on a single industry, such as tech or energy, while others might follow a strategy of dollar-cost averaging by investing small amounts on a regular basis. Investors can also use metrics such as the price-to-earnings ratio to find promising companies with good growth prospects, or consider qualitative factors such as a defensible economic moat or network effects. These can give a company an advantage over new competitors, or allow it to retain customers with a lower cost to serve them than would be possible otherwise. These competitive advantages can help boost a company’s stock, even when earnings don’t rise significantly. As with all investments, there is always a risk that stock values will go down, leaving you with shares worth less than what you paid for them.