Before you can start buying and selling stocks, it’s important to learn the basics. What exactly is stock? How do people make money with stocks? What is some common terminology in the stock market? What makes the price of stock rise and fall? These seemingly simple questions will be answered by the time you finish reading this. I want to make sure that you understand the basics of the stock market.
What is Stock?
In simple words, stock is a piece of a company. When someone buys stock, they are literally buying part ownership of that company.
A share is the term used when describing stock bought from a single company. If you own a portfolio of 20 companies, you would say you own a portfolio of stocks. If you are referring to stock held by a single company (such as Apple), you would say you have 10 shares of Apple.
When a company wants to raise a large amount of money in order to expand its private company, it will create an Initial Public Offering (IPO).
This means they are issuing shares to the public and allowing people to purchase part of the company. By doing this, they give up some freedom of owning their company in order to gain a large amount of investing capital from the investors and using that to grow their business.
Someone that owns 1000 shares of a company, owns 10 times the amount of that company than someone that owns only 100 shares.
What Determines the Price of Stock?
If you haven’t already noticed, the price of stock changes from one company to another. There are a few reasons why stock is worth what it is currently being sold at. The fundamental cause is Supply and Demand. If there are more buyers than sellers, the prices will go up. If there are more sellers than buyers, the price will go down. The price settles when the number of buyers and sellers is about equal.
Imagine you go to a store to buy avocados. Avocados aren’t in season when you go so there are only a few. The price of avocados is $4.00 for each avocado. A few months go by and you go to the same store but find avocados on sale for 2 for $3.00. Now that avocados aren’t as hard to find, the store is forced to lower the price to ensure they all get sold.
That same principle of economics applies to stock. At the writing of this article, Apple shares cost $179 per share. Shares of Hawaiian Airlines meanwhile are only about $30 per share. These two companies are in two different categories of stock known as sectors.
Don’t be fooled though. Just because a stock is worth less than another company’s stock doesn’t mean that the higher-priced stock is better. The number of shares available also plays into this. If a company wants to raise a lot of money, they may issue numerous shares to be purchased.
If a company wants to take more control back, it will buy back its own shares. When a company issues more shares, the value of each share will decrease since there are more opportunities to buy shares (remember the avocados). When a company buys back its shares, the price per share will rise.
How Do You Make Money with Stocks?
There are two main ways to make money with stocks. Both involve the company being successful. If a company is successful, investors will make money. Likewise, if trouble strikes and a company falls on the wrong side of fortune, investors will also lose.
So, the two ways to make money with stock are capital gains and dividends.
1. Capital Gains
Let’s say you buy 10 shares of a company. For this example, we’ll say Microsoft. Now let’s assume Microsoft is currently being traded for $100 per share. 4 months later, the stock rises to $120 per share. That means the stock is worth $20 more than when you bought it (a 20% gain).
Since you have 10 shares, that’s a profit of 10 x $20 or $200! Not bad! If y you then sell your shares, that $200 profit is considered Capital Gains. Now if after 4 months, the price went down to $90 per share, and you sold the shares, you’d have a loss of $100 (10 x $10).
When a company wants to reward shareholders by giving them a portion of the company’s profits, this is called a dividend.
Let’s say a company (in this case, Disney) wants to pay its stockholders a 4% dividend. Usually this 4% will be distributed over the course of the year split up by quarters generally. If Disney stock is $100 per share and we own 10 shares (worth $1000 dollars total), a 4% dividend would be $40 (4% of $100 x 10 shares).
Instead of getting all $40 at once though, it would generally be split up $10 every quarter.
Usually, companies that are more stable will offer larger dividends because they make consistent steady income every year. Newer companies that are starting out will generally not offer dividends and instead reinvest their profits to help grow the company bigger. When this occurs, generally capital gains become the method you will make more money from.
Are Dividends or Capital Gains Better?
This is totally dependent on the investor. Someone that wants to make passive income from their investments may choose high dividend companies so they get a steady payout without buying and selling stock. Another person may be investing for a few years and want to cash in their capital gains all at once by selling all of their shares at a higher price than they bought it.
So there are two different terms for categories of stock. One is the sector and the other is the industry. The important distinction is that there are only a few sectors and there are many industries. Industries also fall under sectors.
Sectors (as categorized by the Global Industry Classification Standard – GICS)
- Health Care
- Real Estate
- Consumer Staples
- Information Technology
- Consumer Discretionary
Industries are broken down into types of businesses that are more specific than sectors. For example, Solar Power is an industry but would fall under the Energy Sector. Mobile Phone Services would be an industry under the Telecommunications Sector. Home Builders would fall under the Real Estate Sector.
Where Can You Buy Stock?
Stock is bought an sold on an exchange. The most common exchange is the New York Stock Exchange (NYSE). In order to purchase stock, you would have a brokerage account. The purpose of the broker is to match a buyer and a seller in order to complete a transaction of stock.
Imagine a brokerage is a store and a broker is a shop keeper. You would go to the shop and choose a product (in this case a company’s stock). You would then go to the shop keeper (the broker) and buy it. The supplier that stocks the shelves would be the seller in this rudimentary example.
Today, it’s never been easier to join a brokerage. There are a lot of big-name brokerage firms such as TD Ameritrade, E-Trade and newer brokerages such as Robinhood and WeBull. To see brokerages that do not charge membership fees or commission fees, check out our article that reviews the best free stock trading platforms.
So, now you have a basic understanding of what stock is and what shares are.
You know how people make money with stock and what drives the price up and down.
You can also categorize stock properly by knowing how to tell the difference between a sector and an industry.
I also briefly covered where you can buy stock and compared brokerages to a neighborhood market.
The next thing you should ask yourself is whether Stock is the right investment for you. I can’t tell you for sure. What I can do though is offer you 3 reasons why investing in stock is a sound investment. Once you determine that investing in stock is the right move, you can read my article on how to find stocks to invest in.
I hope you found this post useful. If you did, please let me know below. Also, if you have questions, feel free to leave those below as well. If you know someone that can benefit from this article or just want to share it with others, you can do that below too!
Thanks for visiting and let’s start investing!
Eric Baglio has been investing for over ten years and learned a lot of valuable lessons along the way. He has helped numerous people start investing on their own and founded Let’s Start Investing to help anyone willing to learn how to build wealth. His favorite brokerage is Webull and his favorite stock advising service is Motley Fool Stock Advisor.