Back to the Basics: What is a Stock?

What I’m Drinking as I Write: Shin Shin Coffee

Most of you have heard of stocks by now. You’ve heard people talk about their investments, retirement accounts, how many shares of a company they own, etc. But could you actually explain to me what the word ‘stock’ means to you in this context? If you would like to learn more, please keep reading.

Simply put, a stock is ownership in a company. But what does that actually tell us? A share of stock in a company is a way to invest in a piece of that company’s future growth potential, yet a stock’s price may not just reflect this growth. Let’s say Company XYZ reports earnings for the quarter (most U.S. companies release quarterly reports with detailed information on its revenue, earnings, etc. for the prior three-month period) and the company grew its earnings (profits) by 10%.   

However, this does not mean an investor will see a 10% increase in the stock price. You see, shares of companies are traded actively in an open market throughout the day. If I were to place a trade to buy a stock, theoretically, there would be another investor on the other side of that trade to sell me his share. This is called supply and demand. When there is more supply than demand for a stock (more investors choosing to sell than to buy) the price of the stock will fall, as would the price of Bread Company ABC if a report came out that its bread was poisonous. Factories would still have bread to sell (supply), yet no one would be buying (decrease in demand), therefore driving prices down. The same goes for the stock market. If a company reports great news, more investors may become interested in purchasing shares, which would increase the demand, and therefore increase the price of each share of stock.

Long story short, a share of a company may not always reflect how much you think the company should be “worth”. Excellent earnings reports, growth across every segment, and growing an organic customer base tenfold could mean absolutely nothing if analysts and investors were expecting better. The price of a stock reflects what other investors think it’s worth.

The act itself of purchasing a share of stock in a company is not difficult. One could simply go online to any trading institution (i.e., Charles Schwab, Pershing, TD Ameritrade), set up an account, transfer money, and purchase the holding of choice. However, what are you actually buying and why? Are you purchasing a stock you read about on your Twitter timeline? Or one that your girlfriend’s brother’s friend said will quadruple over the next week? 

Owning a stock sounds simple and easy; but I encourage you to at least read a little about the company you are going to purchase. Is it a family-owned sandwich company headquartered in Australia that has 12 employees and is trading for $.0001 a share? In a later post I will discuss a few simple things to look for (and avoid) in a company; but for now, at least invest in a company that makes sense. Along with investing in stocks comes risk. Risk of losing your entire investment. You can never fully avoid risk, but you can minimize your exposure to it. One way to achieve this is by practicing due diligence – understand what you are purchasing and why. Purchase shares of stock in a company that you understand. One that you believe has future growth potential that you would like to participate in. One that you would be a proud owner of. I hope by now you have a better understanding of not only what a stock is, but also a few factors that drive the prices of them (stay tuned to learn about more factors in a later post). 

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Lesson:

After beginning college, I began to read general finance books and learned about fundamental vs. technical analysis, a top-down approach (all those fancy buzz words); I even created a financial plan for a mock client in my retirement planning class. Yet I still had no idea how to actually invest in a stock. Of course I knew what a stock was, and what their purpose is – to make (or lose) money, right? I just had no idea how to get from Point A to Point B. It wasn’t until my first job out of college that I opened a Roth 401(k) (a type of retirement savings account through my employer), found a stock I wanted to purchase, went online to a trading platform (a place to buy and sell shares), and placed a buy trade for the first time. Ever since then I haven’t thought twice about the process of finding a company I believe in and purchasing shares – it seems natural to me now. Turning knowledge and ideas into actions can seem daunting at first, especially when you learn so much about the end result you forget you don’t even know how to begin. I hope I can help you begin and follow-through on your own journey post-by-post. I have provided a few links below to websites that I often use when looking for general information on a company. Simply type in the ticker symbol (letters or numbers that identify a company) of any stock and search to get started.

  

Happy Sipping,   
   
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