Stocks for Dummies | Part 1 | The Basics
In the world of finance and investing, few terms carry as much weight and fascination as “stocks.” They capture the imagination of seasoned investors and curious beginners alike, offering the promise of financial growth and wealth accumulation. But what exactly is a stock?
In this blog post, we will embark on a journey to unravel the mysteries surrounding stocks, shedding light on their fundamental nature and exploring their significance in the realm of investments. Whether you’re a novice looking to dip your toes into the market or simply seeking a clearer understanding of this essential financial instrument, this guide will serve as your comprehensive introduction to the world of stocks. Like many of my posts, I use and define several terms throughout. These terms (often bolded) will be defined both in-text and in a table at the end of the article.
What is a Stock?
In finance, stocks (commonly referred to as equity or shares) are financial assets that represent ownership in a company. They are perhaps the most common type of security (financial asset). Large, publicly traded companies have thousands, if not millions, of owners. Think about companies like Apple, Disney, or Coca-Cola. No one person owns these firms in their entirety. Instead, there are millions of individuals, businesses, and other entities that collectively own a percentage of the companies in order to receive a share of the firms’ profits. The profits that companies distribute to their shareholders are called dividends. Dividends represent a portion of the company’s earnings that is distributed to the shareholders as a return on their investment. Dividends are often paid out quarterly.
Anyone can become a shareholder (an owner of a firm’s stock) in large, publicly traded firms by purchasing their stock. In the past, before the internet became prevalent, stocks were physical pieces of paper. If you bought stock in a company, you would receive a certificate that showed the number of shares you owned, the date of purchase, a unique identification number to authenticate the shares, and even a corporate seal from the company. However, nowadays, stock certificates and ownership are all digital, and stocks can be purchased through a brokerage. Brokerages, such as Charles Schwab, Fidelity, and TD Ameritrade, are financial institutions or companies that facilitate the buying and selling of financial securities on behalf of their clients. Essentially, they connect clients to stock exchanges.
Stock Exchanges
A stock exchange, also known as a securities exchange, is a regulated marketplace where buyers and sellers come together to trade various financial instruments, primarily stocks but also other securities. It serves as a platform that facilitates the buying and selling of financial instruments in a transparent and organized manner. The main function of a stock exchange is to provide a centralized marketplace where investors, such as individuals, institutions, and even governments, can trade securities. By bringing together buyers and sellers, the exchange ensures that transactions occur in a fair and efficient manner, with prices determined by supply and demand.
There are many different stock exchanges across the world. The most common exchanges in the US are the New York Stock Exchange (NYSE) and the NASDAQ Stock Exchange (NASDAQ). Other well-known stock exchanges globally include the London Stock Exchange (LSE), the Hong Kong Stock Exchange (HKEX), and the Tokyo Stock Exchange (TSE).
A Recap
To ensure clarity, let’s delve into the following example: Let’s say you believe that Coca-Cola is a great company with significant growth potential and a long-term future. Based on these factors, you decide to purchase Coca-Cola stock. To do so, you log into your online brokerage account and place an order to buy 10 shares of Coca-Cola. Your brokerage receives your order and executes it on your behalf by purchasing the Coca-Cola stock from the stock exchange.
The price per share of Coca-Cola stock is constantly fluctuating. Currently, the stock is trading at $60.90 per share. There are approximately 4,326,000,000 shares of Coca-Cola outstanding, which are owned by various individuals and available for buying or selling. Your purchase of 10 shares means you technically own approximately 0.00000023116% of the entire company (10/4,326,000,000 * 100)!
After a few months of owning the Coca-Cola shares, you receive your first dividend payment. Coca-Cola offers a dividend of $0.46 per share per quarter. Since you purchased 10 shares, you would receive $4.6 per quarter or $18.4 per year in dividends. If the stock price remains constant throughout the year, this would result in an annualized return of 3.02% per year, simply by holding the stock!
The Bottom Line
To summarize, purchasing stocks allows individuals to become owners in companies and receive a share of the profits through dividends. Stock ownership has transitioned from physical certificates to digital holdings, and trading occurs on stock exchanges, which provide a transparent and organized marketplace for buying and selling securities. Understanding the basics of stocks and their role in investing is crucial for anyone looking to navigate the world of finance and capitalize on potential opportunities for wealth accumulation.
