In this article
- What is stock?
- Stock's potential rewards
- Buying and selling stocks
- Demystifying the language of investing
Own a stock: Own a share of a company
Stock represents ownership of a company. If a company is privately held, then its stock may be owned by only a few individuals and is not available for purchase by the public. If a company is publicly held, then its stock can be purchased through stockbrokers by individual investors and institutions alike. Corporations can issue different types of stock, but the most typical is common stock.
By investing in stock, you stake a claim in the future of that company and all the potential investment return that it may bring. With potential reward, however, you also have all the risks associated with owning a company. If a company is forced to liquidate, it is first obligated to pay its creditors, bondholders and those who hold preferred stock (a limited issue stock that does not hold voting rights), before those who own common stock.
As a shareholder of common stock, you have voting rights on issues such as election of a board of directors and other important issues affecting the direction of the company.
Shareholders may also receive dividends, which are paid to shareholders from the company's earnings. The amount of the dividend is decided by the board of directors, and is based on what portion of earnings needs to be reinvested in the growth of the company and what portion can be distributed to shareholders.
The potential rewards of stocks
Stocks carry higher investment risks than bonds or money market investments, but they also have historically realized higher rates of return over longer holding periods (see chart). While past performance doesn't guarantee future results, the higher return potential of stocks can make them suitable investments for long-term investors seeking to build the value of their portfolios or to stay ahead of inflation. Both of these objectives are critical to investors with specific long-term goals in mind, such as saving for retirement.
Ways of Categorizing Stock Investments
Size of Company
The market value (capitalization) of the company determines whether it is considered a large-, mid-, or small-cap stock.
Stocks of companies that are forecasted to increase earnings by 15% or more per year. Of course, there is no guarantee that this objective will be met.
Stocks of companies that are priced near their asset value (with no growth in earnings assumed) are called value stocks. They may or may not be bargains, however, depending on whether their prices subsequently recover.
Stocks of companies headquartered outside the United States in industrialized countries.
Stocks of companies headquartered in underdeveloped, fast-growing countries.
Type of industry, such as technology, energy, or cyclicals.
Average Annual Rates Of Return
Consider how various stocks have performed versus other investments over the 30 years ended December 31, 2015.
Source: ChartSource®, DST Systems Inc. For the period ended December 31, 2015. Large-cap stocks are represented by the S&P 500 index. Midcap stocks are represented by a composite of the CRSP 3rd-5th deciles and the S&P 400 index. Small-cap stocks are represented by a composite of the CRSP 6th-10th deciles and the S&P 600 index. Bonds are represented by the Barclays Aggregate index. Cash is represented by a composite of the yields of 3-month Treasury bills, published by the Federal Reserve, and the Barclays 3-Month Treasury Bills index. Foreign developed stocks are represented by the MSCI EAFE index. Different investments offer different levels of potential return and market risk. International investors are subject to higher taxation and currency risk, as well as less liquidity, compared with domestic investors. Midcap stocks and small-cap stocks are generally subject to greater price fluctuations than large-cap stocks. Bonds are guaranteed as to the timely payment of principal and interest. Past performance is not a guarantee of future results. It is not possible to invest directly in an index. Past performance is not a guarantee of future results. It is not possible to invest directly in an index. Copyright © 2016, DST Systems Inc. All rights reserved. Not responsible for any errors or omissions. (CS000168)
Tactics for managing risk
Before investing, weigh the potential risk of loss of principal against the risk of not meeting your investment goals or of losing purchasing power to inflation.
Stock investors can also manage risk by:
Investing in just one or two stocks is generally much more risky than buying stocks of 15 or 20 companies. By holding stocks of different companies in several industries, you limit your exposure to a substantial loss due to a price decline in just one stock.
Appropriate Asset Allocation
This refers to how you spread your portfolio among different types of investments, such as stocks, bonds, and money market investments.
An aggressive investor with a long-term horizon might choose to keep 80% of his or her portfolio in stocks, for example, with the remaining 20% in bonds and money market funds. This adds yet another level of diversification to the portfolio and can further reduce investment risk. Your financial professional can help you select an asset allocation that is appropriate for your goals and time frame.
Weathering Market Fluctuations
Staying invested through periods of market turbulence can also help manage risk of loss as the variability of returns tends to decrease over time.
Buy Stocks Individually or Grouped in Mutual Funds
Individuals can buy stocks directly or can purchase mutual funds or annuities which may invest in individual stocks. An employee may also have an opportunity to buy stock in his or her company through a company stock purchase plan or retirement plan.
Many financial analysts believe that most people can best access the stock market by buying shares of mutual funds that invest in stocks. There are thousands of mutual funds investing within a variety of stock market categories and sectors. Mutual funds offer the potential advantages of professional money management, diversification, and liquidity. These advantages are particularly apparent when investing in international and emerging market stocks, which are often less accessible to individual investors. Your financial professional can help you assess which types of mutual funds may be suitable for your portfolio.
Investors with, say, $20,000 or more to invest and who want to manage their own portfolio can build a diversified portfolio with just 15 to 30 stocks. Even though it may seem to be a daunting task to find companies in which to invest, basic information on most publicly traded companies is available online, at libraries, and best of all, through information and guidance provided by your financial professional.
A glossary: Demystifying the language of investing
The price of a stock is determined according to the rules of supply and demand. Tracking the price over time can give you a partial picture of the company and its recent performance. Daily information in national newspapers includes the high and low price for the stock in the previous 52 weeks.
Price-to-Earnings Ratio (A.K.A. "P/E")
This number, which is derived by dividing the stock price by the company's earnings per share, is used to determine what an investor is paying for the earning power of the company. It is one figure that can be used in comparing the value of several companies even though their prices may be vastly different.
The dividend yield, determined by dividing the amount of the dividend by the share price, simply indicates what percent return the company is paying its investors. National newspapers report the return on both the initial investment at the time of the first public offering and the return on the current value of the stock. This number can also be used in a comparison of companies.
This figure represents the percentage of earnings a company is paying out to its investors. It is an indication of whether most of a company's earnings are being paid to its investors, or whether they are being reinvested in the growth of the company.
In addition, a fundamental approach to stock investing considers the following questions:
- How does the company compare to its competitors in earnings growth and profitability?
- Are there any outside factors such as government regulations that may affect the entire industry?
- What is the projected demand for the company's product?
- Is the industry a cyclical one; i.e., does it move up and down in cycles?
- What are management's goals and how are they going to achieve them?
Because of their long-term potential, stocks have a place in nearly every portfolio.
Speak with your financial professional about how you can best include stocks in your portfolio.
© 2016 DST Systems, Inc. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.
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GE 90985 (04/2016)