This day and age is truly amazing for any business. Businesses just starting up may however need a hand with funding their business. This is when they create stocks, where they look to make money to begin their business with, and where you can find some serious potential in making some serious money. In order to become successful in the stock market, we must first fully understand what the stock market is, and how it can be used to generate wealth.
What is the Stock Market?
Let’s start with the definition of a stock. A Stock is “the capital raised by a business or corporation through the issue and subscription of shares.”, in simple terms, a stock represents legal ownership in a business. Corporations issue stock usually in one of two ways: as a common stock or as preferred stock.
A Common Stock is the stock everyone usually refers to when they talk about investing. They are pieces of the company that entitle their holder to dividends that vary, depending on the fortunes of the company.
The shareholders of a Preferred Stock receive a specified amount at predetermined times. Not only that, they also give the preferred stock holder a greater claim to the company’s bondholders, payment before the common stock holders, and dividends that are typically guaranteed, meaning that if the company misses one, they will be required to pay it before further dividends are paid on either stock.
If market means to advertise or promote something, that would make the stock market the promotion and selling of stocks, in attempt to, of course, make a profit.
How are Stocks Created, and What is their Purpose?
There are many reasons to why stocks exist, but the most important are among the following:
- A stock allows a business to raise money in order to turn their idea into a successful business. Without these capital markets, most of the modern comforts you take for granted wouldn’t exist, let alone be available for you to use.
- Stocks separate ownership from management, allowing those who have no time or interest in starting an enterprise to still participate in economics. This results in more efficient distribution of resources, including money.
- Stocks provide investors the opportunity to potentially earn satisfactory returns on money, which might allow them to achieve their financial goals faster than they otherwise could.
Stocks allow people to put money in, which leads to making the business happy by giving them startup money, making themselves happy by getting a percentage of the businesses profit, and making the consumer happy by offering them an innovative product / service. Pretty cool how investing in stocks can make everyone happy, isn’t it?
How do Stocks Work?
To answer the question much simpler, I will give you a scenario. Let’s suppose you want to start a restaurant with members of your family. You do some calculations and decide that $150,000 should be enough to get your business off the ground.
Knowing this, you divide the company into 1,500 shares of stock, pricing each share at $100. If you can sell all the shares to your family members, you should have the $150,000 you need (1,500 shares x $100 per share = $150,00 raised for your company).
Let’s now suppose that after your first year, your restaurant earned $80,000 (after taxes), each share of the stock would be entitled to 1/1,500th of the profit. So you would take that $80,000 and divide it by 1,500, which would result in about $53 in earnings per share. Once you have figured that out, you can then you can call a Board Meeting, and discuss whether you want to pay out the dividends, repurchase more stock, or further expand the company.
At some point, you may decide you want to sell your shares of the restaurant. If the company is large enough, you could have an IPO, allowing you to sell your stock on a stock exchange. As a matter of fact, that is exactly what happens when you buy or sell shares of a company through a stock broker. You tell the market you are interested in acquiring or selling off shares of a company, and Wall Street will match you with someone who is willing to take the other side of your trade.
In What Ways Can an Investor Make Money by Owning Stocks?
There are 3 ways in which a stockholder can make money off of their stock:
- You can collect the cash dividends that are sent for your cut of any profits generated by the company.
- You can watch the increase in the value of your share and maybe sell it when it is at a peak.
- You can realize the profit from the increase in what your share is earning you.
How Can I Begin Buying Stocks?
How Can I Invest Money in Stocks?
There are 4 major ways to invest your money in stocks:
- Investing through your 401k plan.
- Investing through an Individual Retirement Account (IRA).
- Investing through your brokerage account.
- Investing through a direct stock purchase plan or dividend reinvestment plan (DRIP).
Do Your Research!
When you are researching a potential investment, there are some main documents that you will want to look at before purchasing. These documents should be very easy to find and include:
- A Form 10-K, which is the annual filing of the Securities and Exchange Commission (SEC), which is available to investors of a company.
- Form 10-Q, which is a quarterly from of the form 10-K..
- The most recent Annual Report, where you will want to pay attention to the letter from the Chairman (CEO) or the CFO to see how they view the business.
- A Statistical Showing going back five to ten years.
Next, you should decide whether to hold the stocks yourself or hire a middleman to do it for you. There are drastic differences between them, so make sure you pick the one best suited for you.
Hire an Index Fund to Hold Them for You
Index funds can be a great choice under certain circumstances for the right investor, keep in mind they are not a type of investment rather just a collection of individual stocks. If you aren’t going to choose your stocks yourself or hire an asset management company to do it for you, you are handing the task to a group of men and women that work for a Wall Street Institution.
Hold the Stocks for Yourself
Deciding on which stocks you want to hold can prove to be difficult and depends on numerous factors. A common mistake that most people make when starting is thinking that the goal of investing in stocks is to maximize absolute return, when in some cases, it may be better to get satisfactory return at a minimum risk or it may be better to increase potential return by focusing more on higher than average dividends. When looking for companies to invest in, you may want to look for a handful of characteristics that include:
- Stocks of businesses that have a long history of increasing profitability through their business cycle, with at least one recession.
- Stocks of businesses that have a significant competitive edge that makes it difficult for competitors to unseat their enterprise.
- Stocks of businesses that have a good shareholder management along with Board of Directors willing to return excess money to owners through ever-increasing dividends and share repurchases.
Perfecting Your Stock Portfolio
When you look at how different stocks fit together as an overall portfolio, you don’t want all your money in one industry, like banking or oil, but rather attempt to offset things, taking correlated risks.
It is awesome to have investment holdings in multiple industries, because if one fails, you have others to back you up, and if many flourish, that is just even more money in your pocket, rather than waiting until that one industry flourishes, if ever, and being broke at some points, due to the industries struggle.
Think about it, lets say there are 100 types of cookies being sold you buy multiple shares of one of the cookie type and hope that kind sells. At a rate of one cookie flourishing at a time, you have a 1% chance of yours flourishing, but if you have one share for 10 types of cookies, that increases your chance of flourishing to 10%!
Moving forward, I have two things I hope you remember while buying stocks, one is to do your research before buying a stock, and two is to buy a huge variety of stocks. You have made it to the end of this article, that shows commitment, stick with it, keep working, and I am certain you will achieve greatness within the stock market.
As with all my posts, if you have any questions be sure to leave the in the comment section below.