Stocks are also called shares or a company's equity. Stock ownership implies that the shareholder owns a slice of the company equal to the number of shares held as a proportion of the company's total outstanding shares. Most companies have outstanding shares that run into the millions or billions. While there are two main types of stock— common and preferred —the term equities is synonymous with common shares, as their combined market value and trading volumes are many magnitudes larger than that of preferred shares.
The main distinction between the two is that common shares usually carry voting rights that enable the common shareholder to have a say in corporate meetings like the annual general meeting or AGM where matters such as election to the board of directors or appointment of auditors are voted upon while preferred shares generally do not have voting rights.
Preferred shares are so named because preferred shareholders have priority over common shareholders to receive dividends as well as assets in the event of a liquidation.
Common stock can be further classified in terms of their voting rights. While the basic premise of common shares is that they should have equal voting rights—one vote per share held—some companies have dual or multiple classes of stock with different voting rights attached to each class. In such a dual-class structure , Class A shares , for example, may have 10 votes per share, while the Class B subordinate voting shares may only have one vote per share.
Dual- or multiple-class share structures are designed to enable the founders of a company to control its fortunes, strategic direction, and ability to innovate.
Today's corporate giant likely had its start as a small private entity launched by a visionary founder a few decades ago. Technology giants like these have become among the biggest companies in the world within a couple of decades. However, growing at such a frenetic pace requires access to a massive amount of capital. In order to make the transition from an idea germinating in an entrepreneur's brain to an operating company, they need to lease an office or factory, hire employees, buy equipment and raw materials , and put in place a sales and distribution network , among other things.
These resources require significant amounts of capital, depending on the scale and scope of the business startup. A startup can raise such capital either by selling shares equity financing or borrowing money debt financing. Debt financing can be a problem for a startup because it may have few assets to pledge for a loan—especially in sectors such as technology or biotechnology , where a firm has few tangible assets —plus the interest on the loan would impose a financial burden in the early days, when the company may have no revenues or earnings.
Equity financing, therefore, is the preferred route for most startups that need capital. The entrepreneur may initially source funds from personal savings, as well as friends and family, to get the business off the ground. As the business expands and capital requirements become more substantial, the entrepreneur may turn to angel investors and venture capital firms.
When a company establishes itself, it may need access to much larger amounts of capital than it can get from ongoing operations or a traditional bank loan. It can do so by selling shares to the public through an initial public offering IPO. This changes the status of the company from a private firm whose shares are held by a few shareholders to a publicly-traded company whose shares will be held by numerous members of the general public.
The IPO also offers early investors in the company an opportunity to cash out part of their stake, often reaping very handsome rewards in the process. Once the company's shares are listed on a stock exchange and trading in it commences, the price of these shares fluctuates as investors and traders assess and reassess their intrinsic value.
There are many different ratios and metrics that can be used to value stocks, of which the single-most popular measure is probably the price-to-earnings PE ratio.
The stock analysis also tends to fall into one of two camps— fundamental analysis , or technical analysis. Stock exchanges are secondary markets where existing shareholders can transact with potential buyers. It is important to understand that the corporations listed on stock markets do not buy and sell their own shares on a regular basis.
Companies may engage in stock buybacks or issue new shares but these are not day-to-day operations and often occur outside of the framework of an exchange.
So when you buy a share of stock on the stock market, you are not buying it from the company, you are buying it from some other existing shareholder. Likewise, when you sell your shares, you do not sell them back to the company—rather you sell them to some other investor.
The first stock markets appeared in Europe in the 16th and 17th centuries, mainly in port cities or trading hubs such as Antwerp, Amsterdam, and London. These early stock exchanges, however, were more akin to bond exchanges as the small number of companies did not issue equity. In fact, most early corporations were considered semi-public organizations since they had to be chartered by their government in order to conduct business.
Prior to this official incorporation, traders and brokers would meet unofficially under a buttonwood tree on Wall Street to buy and sell shares. The advent of modern stock markets ushered in an age of regulation and professionalization that now ensures buyers and sellers of shares can trust that their transactions will go through at fair prices and within a reasonable period of time. Today, there are many stock exchanges in the U. This in turn means markets are more efficient and more liquid.
These shares tend to be riskier since they list companies that fail to meet the more strict listing criteria of bigger exchanges. Larger exchanges may require that a company has been in operation for a certain amount of time before being listed and that it meets certain conditions regarding company value and profitability.
In most developed countries, stock exchanges are self-regulatory organizations SROs , non-governmental organizations that have the power to create and enforce industry regulations and standards. The priority for stock exchanges is to protect investors through the establishment of rules that promote ethics and equality. The prices of shares on a stock market can be set in a number of ways.
The most common way is through an auction process where buyers and sellers place bids and offers to buy or sell. A bid is the price at which somebody wishes to buy, and an offer or ask is the price at which somebody wishes to sell. When the bid and ask coincide, a trade is made.
The overall market is made up of millions of investors and traders , who may have differing ideas about the value of a specific stock and thus the price at which they are willing to buy or sell it. A stock exchange provides a platform where such trading can be easily conducted by matching buyers and sellers of stocks. For the average person to get access to these exchanges, they would need a stockbroker.
This stockbroker acts as the middleman between the buyer and the seller. Getting a stockbroker is most commonly accomplished by creating an account with a well-established retail broker. The stock market also offers a fascinating example of the laws of supply and demand at work in real-time.
For every stock transaction, there must be a buyer and a seller. Because of the immutable laws of supply and demand, if there are more buyers for a specific stock than there are sellers of it, the stock price will trend up. Conversely, if there are more sellers of the stock than buyers, the price will trend down. The bid-ask or bid-offer spread the difference between the bid price for a stock and its ask or offer price represents the difference between the highest price that a buyer is willing to pay or bid for a stock and the lowest price at which a seller is offering the stock.
A trade transaction occurs either when a buyer accepts the ask price or a seller takes the bid price. If buyers outnumber sellers, they may be willing to raise their bids in order to acquire the stock. Sellers will, therefore, ask higher prices for it, ratcheting the price up. If sellers outnumber buyers, they may be willing to accept lower offers for the stock, while buyers will also lower their bids, effectively forcing the price down.
Some stock markets rely on professional traders to maintain continuous bids and offers since a motivated buyer or seller may not find each other at any given moment. These are known as specialists or market makers. A two-sided market consists of the bid and the offer, and the spread is the difference in price between the bid and the offer.
Successful investing requires time, patience and a clear and realistic plan directed toward your goal. There are three factors that can affect the likelihood that your financial goals are met: your time horizon, the rate of return on your investments, and the amount you invest. The more time you have to build wealth, the more potential there is to reach your goals.
The cost of waiting to begin an investing program can be significant. The advantage of starting early allowed Jane to invest less, but finish with more money. The clear benefit: start early and give your investment more time to grow. Earning a higher rate of return will build wealth faster, but to earn higher returns, you may need to invest in securities with more risk and volatility, or price change.
It is important to understand the relationship between risk and return. Investors can seek higher return potential over time for taking more risk. Lower risk investments typically return less over time. Risk is demonstrated by volatility.
Riskier investments will have larger, faster moves in price than lower risk investments. Low risk investments have a higher probability of principal protection, or less price change. A simple strategy is to start with a regular investment plan and increase your contributions a small amount each year. Doing so will have a positive impact on your ability to build wealth. Below is an example of how this works with a mutual fund investment.
Two factors create the magic of compounding:. Active investing means taking time to research investments yourself and constructing and maintaining your portfolio on your own.
If you plan to buy and sell individual stocks through an online broker , you're planning to be an active investor. To successfully be an active investor, you'll need three things:. On the other hand, passive investing is the equivalent of putting an airplane on autopilot versus flying it manually. You'll still get good results over the long run, and the effort required is far less.
In a nutshell, passive investing involves putting your money to work in investment vehicles where someone else is doing the hard work -- mutual fund investing is an example of this strategy.
Or you could use a hybrid approach. For example, you could hire a financial or investment advisor -- or use a robo-advisor to construct and implement an investment strategy on your behalf. Dig deeper: Active vs Passive Investing. The amount of money you're starting with isn't the most important thing -- it's making sure you're financially ready to invest and that you're investing money frequently over time.
One important step to take before investing is to establish an emergency fund. This is cash set aside in a form that makes it available for quick withdrawal. All investments, whether stocks, mutual funds, or real estate, have some level of risk, and you never want to find yourself forced to divest or sell these investments in a time of need.
The emergency fund is your safety net to avoid this. Most financial planners suggest an ideal amount for an emergency fund is enough to cover six months' worth of expenses. While this is certainly a good target, you don't need this much set aside before you can invest -- the point is that you just don't want to have to sell your investments every time you get a flat tire or have some other unforeseen expense pop up. It's also a smart idea to get rid of any high-interest debt like credit cards before starting to invest.
Not all investments are successful. Each type of investment has its own level of risk -- but this risk is often correlated with returns. Even within the broad categories of stocks and bonds, there can be huge differences in risk. For example, a Treasury bond or AAA-rated corporate bond is a very low -risk investment, but these will likely have relatively low interest rates.
Savings accounts represent an even lower risk, but offer a lower reward. On the other hand, a high-yield bond can produce greater income but will come with a greater risk of default. One good solution for beginners is using a robo-advisor to formulate an investment plan that meets your risk tolerance and financial goals. In a nutshell, a robo-advisor is a service offered by a brokerage that will construct and maintain a portfolio of stock- and bond-based index funds designed to maximize your return potential while keeping your risk level appropriate for your needs.
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