When you buy stock, you own a sliver of ownership in a company. The hope is that the company will do well, and that its value—and your investment—will rise. If you sell your shares for more than what you paid, you’ll earn a return—that’s called a capital gain. Historically, stocks have generated higher returns than other asset classes like bonds, real estate and commodities.
Unlike bonds, which operate like loans, stocks function as part of the equity market and enable companies to raise money from investors. A company issues stock to grow into new markets or expand existing ones, and the price of the stock fluctuates based on many factors, from overall market volatility to news about a specific company.
There are two primary ways to earn returns on stocks: capital gains and dividends. Capital gains are a result of your participation in the company’s growth. The more successful a company is, the more its share prices rise, and the more profits you’ll make. Shares are valued at either their fair value, which is a valuation based on the company’s fundamentals, or market value, which is determined by supply and demand in the marketplace. Ultimately, your shares are only worth the amount that someone is willing to pay for them—and you can always buy or sell them at any time.
Dividends are the periodic payments a company makes to shareholders from its revenue. These are not guaranteed, and the size of a company’s dividend depends on its profit and financial health. The amount you receive is also dependent on whether it’s taxed at ordinary income rates, qualified dividends (which are taxed at a lower rate) or corporate income taxes, which vary by country.
As a part of your overall investing strategy, you can use stock to diversify your portfolio by country or sector, as well as through style—growth, value and dividend investing—or even within a specific industry. For example, you can invest in large-cap stocks to get broad exposure or blue-chip stocks, which are generally mature companies with a stable track record. You can also choose to focus on companies of a certain size or industry, such as tech, industrials and consumer staples.
When you’re choosing individual stocks, consider factors such as the company’s performance and history, its financial position and outlook, management quality, and the potential for future growth. You can also evaluate a company’s competitors and the industry landscape. In addition, keep in mind that macroeconomic trends can affect the market, including government policies, interest rates and investor sentiment. Moreover, different types of stocks exist, and they’re often divided into share classes that differ in voting rights or restrictions. For example, common stock holders may receive one vote per share while Class A shareholders might have more votes than Class B shareholders. This is why it’s important to carefully research companies before buying their stock.