What
are Stocks?
What are Stocks? Is it worthwhile investing in Stocks? How risky is it? What are the returns one can expect from investment in Stocks?
A stock is a share in the ownership of a company. It represents a claim on the company's assets and earnings. When you buy a company's stock, it means that you are one of the owners or shareholders of the company. Ownership in the company is determined by the number of shares you own divided by the total number of shares outstanding. Stocks are also known as shares or equity.
Features of a Stockholder:
• Being a shareholder means that you are entitled to a portion of the company’s profits and have a claim on its assets. Profits are sometimes paid out in the form of dividends. The more stocks in a company that you own, the larger is the portion of the profits you will get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you will receive what is left after all the creditors have been paid.
• A stock has limited liability which means that, as an owner of a stock, you will not be personally liable if the company is not able to pay its debts. Owning stock means that the maximum value you can lose is the value of your investment. Even if the company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
Once a company has sold shares of its stock to the public, those shares can then be resold by the initial buyers to other investors. The buying and selling of stock is done on a stock market exchange. The demand for a stock rises and falls on the exchange due to a number of different reasons and as a result, the prices of the stock will also fluctuate. Price fluctuations create an opportunity for investors to make money through capital gains. Capital gains are profits that that can be made when a stock is bought for one price and then later sold for a higher price. Capital losses are the opposite of capital gains and occur when the investor sells the stock for a lower price than the original price.
An investor takes on a certain amount of risk when investing in a company's stock. The investor could lose most or all of the money if the stock prices fall or the company goes bankrupt. The stocks are subject to two types of risk:
• Market risk: is the risk that a particular stock's price will be affected by overall stock market movements.
• Non market risk: this is also known as specific risk. This risk occurs as a result of events specific to a company or its industry which could adversely affect the stock's price.
Non market risk can be reduced through diversification. By owning several different stocks in different industries whose stock prices have no relation to each other, you can reduce the risk of non market factors adversely affecting your total portfolio.
While stocks offer no guarantees to investors, they have performed better than any other type of investment over long periods of time. Stocks have historically returned an average of about 11% per year. Over a long-term, stocks are the best bets for overcoming inflation and accumulating wealth. Every investment carries some degree of risk, and the level of risk typically correlates with the return you can expect to receive. Low risk generally means low yields, and high yields typically involve high risk.
