If you are thinking that you don’t understand stocks, join the club. Many people, even those who already own stocks, feel that way. And for some, the confusion is enough to keeps them from ever investing.
A friend of mine recently asked me to explain it as if she were in kindergarten. I’m not sure I can do that, but I’ll try to break the concept down into easy to digest financial morsels.
Understanding stocks checklist
Here’s a basic “understanding stocks” checklist to help get you started:
- Companies issue shares of stock to help provide financing for their existence and growth.
- When you own shares of stock, you own some percent of the company. Usually a very small percentage for us regular investors.
- There are a limited number of shares, as determined by company management and their Board of Directors. (They can issue more at some point or split, but we can let that go for now.)
- When you want to buy some stocks, someone else has to be willing to sell them at the same time.
- Stock prices, while based on some financial fundamentals, are heavily influenced by psychology — and at times by hype.
- If it’s a hot industry or the stock itself has some exciting prospects, then the stock may cost way more than it might otherwise.
- Stocks often sell at some number of times the actual base value of the company. (Usually based on some multiple of earnings.)
- The hotter the stock or industry, the more “times earnings” the price will rise to.
- Really hot stocks and industries may support companies with negative earnings and still high prices for the stock. This is based on anticipated earnings — which may or may not ever happen.
Buying and selling stocks
- You can buy any number of shares you want, but most people buy in multiples of 100 shares.
- When it comes time to to sell, it’s easier to sell in multiples of 100 shares at a time, since most people are looking to buy in multiples of 100. A buyer has to be there or you can’t sell.
- That’s why stock markets exist — to provide a central marketplace for buyers to find sellers and vice versa. Like a flea market, but for shares of public companies.
- If you have an “odd lot” (not an even multiple of 100), you may have to take a little less in price waiting for the right person to buy your shares or to combine with other “odd lot” people.
- So, if you can, buy in multiples of 100 to begin with. Still, “odd lots” are ok. And most likely you will easily find people to sell to unless something is very wrong.
- You can buy stocks from any online discount broker, from a bank with a brokerage division, or from any other legitimate brick & mortar or online brokerage firm. (Just make sure to check around and compare fees and any other charges or requirements.)
Some expectation management
- If you buy individual stocks dreaming of hitting it big, just know that, as with anything you buy, you can get a lemon. And it is not fun watching a price sink or even go to zero.
- Any stock is still only as good as the company that issues the stock. Even great ideas can be badly managed. Or outside forces like competition, industry shifts, regulations, etc. can change a stock’s prospects. So don’t get stuck on a smart concept having to yield profits.
- Then again, stock markets go up and down. And so do stock prices. Even the best stocks can head down for a while. So don’t get thrown by price variations. If it’s a good company, holding is usually the smart move.
- Still, an individual stock’s ability to tank despite a good market is why it’s safer to invest in funds or by “diversifying” your investments, meaning you have enough other stocks / bonds / savings / CDs / etc. to help balance any stinkers.
- Over time, being willing to accept average steady growth over dreams of huge get-rich wins can get you further. Although big wins do happen.
- So if you want to own some stock and understand the risk (even if you still don’t understand stocks all that much), by all means do it.
- Just makes sure if you are only investing in one or two stocks without diversifying (see below), that it’s money you can afford to lose. Or not touch for many years if things do go wrong.
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