What are stocks?
Stocks are financial securities that are traded on a public stock exchange and represent partial ownership or equity in a for-profit business. For example, if there are 100,000 shares of stock in a company and you own 1,000 shares, then you own 1% of the company. In that case, you have the legal right to 1% of the dividends paid by the company, as well as 1% of the value of any assets of the company that are left over after paying off creditors in the event of a bankruptcy.

Most importantly, since stocks represent partial ownership in a business, the prices of stocks rise (and, unfortunately, also fall) based on the future financial prospects of the business. Investors constantly speculate on the future prospects of the business, which leads to constantly changing stock prices. If you:

  • buy stock at $100 a share and sell it at $110 a share because investors are more optimistic about the future of the business, then you have made a $10 per share (or a 10%) profit.
  • sell it at $90 a share because investors are more pessimistic about the future of the business, then you have incurred a $10 per share (or a 10%) loss.

Companies issue stock to the public on a stock exchange such as the New York Stock Exchange (NYSE) or NASDAQ Stock Exchange, in order to raise capital. This capital can be used for various purposes, including funding the growth of the business, paying off debt and/or enabling the founders, management and early investors to cash out of some or all of their investment in the company.

When a private company first goes public by selling stock to investors on a stock exchange, it is called an initial public offering (IPO). If a company is already publicly traded and sells additional stock to investors, that is a called a secondary offering. Once a stock is available on a stock exchange, it can be traded (bought and sold) by investors whenever the exchange is open. The company does not get any additional capital from such trading, but the changing stock price sends important signals to management about whether they are managing the business well or not.

Different types of stocks
Stocks are usually classified by investors based on various characteristics. For example, growth stocks are typically the stocks of companies that are expected to grow their sales and profits rapidly, typically 10% or more annually. Growth stocks usually trade at high valuation levels, in terms of the stock price in relation to fundamental financial accounting metrics such as:

  • sales,
  • profits (sales less expenses) and
  • book value (also known as net worth, which is assets less liabilities).

By contrast, value stocks are stocks that trade at low valuation levels, but typically also have weak growth prospects.

The good news is that lots of money can be made in both types of stocks if you invest in them in the right way and at the right time.

Another way stocks are often classified is based on their sector or industry. Major sectors include:

  • Technology,
  • Media,
  • Telecommunications,
  • Healthcare,
  • Consumer Staples,
  • Consumer Discretionary,
  • Industrials,
  • Materials,
  • Financial Services,
  • Utilities and
  • REITs (which stands for Real Estate Investment Trusts).

Different sectors have different characteristics that make them attractive at certain times and to certain investors. For example, during a period of strong economic growth and technological innovation, Technology stocks usually provide strong returns. During a recession, Consumer Staples (such as Coca-Cola and Procter & Gamble) and Healthcare are usually “defensive” and tend to outperform during a bear market in stocks. For investors seeking income from high dividend yields, Utilities and REITs are often good sectors.

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