Wednesday, July 9, 2014

The Basics of Stocks

A share of stock is a small piece of ownership in a company, just like a piece of pie. By owning a piece of a company, you are entitled to a share of the profits, through dividends, and voting rights on substantial changes in the corporation. As a shareholder of a public company, you do not hold any legal obligation to the company. This means that you cannot be held liable if a company’s product results in deaths or injuries, or be sued if a company that you hold stock in is sued.

A company that has shares of stock and is traded on a public exchange such as the New York Stock Exchange, or the NASDAQ, is called a public company. Private companies may have shares of stock, but they are not traded on a public market. For example, Ford Motor Inc. is considered a public company while the local ice cream shop in your town is probably a private company. The stock exchanges create a place to buy and sell shares of stock, which creates a more efficient market by increasing the liquidity of assets.

If you buy a share of stock in XYZ Corporation at $10 and it rises to $15 in a week, the stock has appreciated $5. This does not mean you have made a profit. You can only make a profit from dividends and the money that you receive after you have sold the stock. When you sell your stock of XYZ Corporation, at $15, then you will have made a $5 profit. If you held onto your share of XYZ Corporation for another week and the price decreased to $5 and you sold it, you would have lost $5. The price of the stock will appreciate, as more people want to own the stock, usually because the business is growing and becoming more profitable and vice versa.

The laws of supply and demand fundamentally determine the price of a share of stock. There are a finite number of shares, meaning that stocks that are in higher demand will be more valuable. The opposite also holds true. If a company is under performing, the demand for the stock will decrease and so will the price. Just because the price of a stock is low does not mean that the company is a poor investment, maybe the company just missed their quarterly earnings or a tsunami in Asia disrupted their supply chain. The company may still have sound fundamentals and a strong management team. There are a lot of factors that go into play to determine the price of a stock. When buying a stock there is always one idea that is necessary to keep in mind, there is always someone that thinks it’s time to sell and someone that thinks it’s time to buy.