Stocks, company shares or equities—whatever you call them, they’re a critical component of many investors’ plans to build wealth. But they can be complex, and prices are often volatile. Investing in stocks involves risk, including the potential loss of principal. Generally, over the long term, however, stock markets have outperformed other asset classes like bonds and real estate.
A stock is a share of ownership in a publicly traded corporation. It gives you a portion of the company’s earnings and assets, and may also give you voting rights on decisions affecting the company. Companies issue stock to raise cash, which can help them pay off debt or fund growth projects that they don’t want or can’t afford to finance with new loans. As the company grows and earns more money, its shares typically increase in value. This is called “share appreciation,” and it’s one of the most important reasons why people buy stocks.
Investors can find stock opportunities in a variety of ways, from individual companies to broader market indexes or mutual funds. It’s important to consider your own investment style and goals when selecting which kinds of stocks to buy. Individual investors, for example, might want to focus on large-cap stocks or use a screener to find undervalued mid- and small-cap companies that can offer outsized returns. Other investors, on the other hand, might prefer to diversify their investments by industry or use a strategy called dollar-cost averaging, where they regularly invest a fixed amount over time, buying more when prices are low and less when they’re high.
Regardless of which stocks you choose, it’s important to understand that the prices of most stocks continuously fluctuate based on changes in marketplace demand and supply. Strong economic conditions usually drive demand higher, while a weak outlook and uncertainty generally cause demand to decline. In addition, specific news about a particular company or economy can send a stock’s price either up or down—even if it doesn’t really change anything.
There are several different ways to classify stocks, and each approach has advantages and disadvantages. For example, capitalization-weighted indices, which are commonly used in indexed mutual funds and exchange-traded funds, tend to overweight larger companies. This can lead to overconcentration in a few stocks, which is why it’s generally preferable to hold diversified portfolios of individual stocks.
Other common stock classification systems include industry and style. Tech, industrials and financial stocks, for instance, may all be grouped together because they’re generally expected to react in similar ways to economic conditions. On the other hand, health care, consumer staples and utilities can be considered more defensive sectors that are less prone to market volatility. Lastly, companies can issue multiple classes of stock, which might be differentiated by things like voting rights or priority in receiving profits and liquidation proceeds. Generally, higher-priced stock classes have fewer voting rights than lower-priced ones. However, this doesn’t mean that all stocks are created equal. In fact, sometimes even the most expensive stocks can outperform cheaper ones in the long run.