Understanding Stocks: What Does It Mean to Own a Stock?

Whether you’re a seasoned investor or a curious newcomer to the world of stocks, this article is for you. In it, we will explain what stocks are, how they work, and why you should invest in them. Additionally, we will present different kinds of stocks and differentiate them from commonly confused investment terms such as bonds and IPOs. So, without much ado, let’s get into it.

How Do Stocks Work?  

Stocks can seem complex, but they’re pretty straightforward at their core. To help understand them, imagine a company as a pie. Each slice of that pie represents a share of ownership in the company. 

So, when the company wants to raise money, it metaphorically “cuts” this pie into slices. Then, it offers these slices (stock) for sale on a stock exchange, a specialized marketplace for these pie slices.

Investors then bid for these shares, anticipating the company’s success and the potential appreciation of their stakes. They can then opt to sell them for a profit later. Alternatively, they can continue holding them, drawing dividends from the company’s profits.

It’s important to remember that stock prices fluctuate quickly. That’s because the laws of supply and demand determine their movements. Various factors, including the company’s performance, prevailing economic conditions, and investor sentiment, can impact the value of a given equity.

Check out our quick guide on how to monitor stock price movement.

How Do You Make Money From Stocks?  

There are primarily two ways to make money from stocks. The first and most common way is through capital appreciation. Here, you buy stocks at a lower price and sell them at a higher price later. 

This profit stems from the increase in the market value of the stock over time, influenced by various factors such as:

• Company performance – Robust financials, new product launches, or positive market sentiment can increase the company’s stock price.
• Overall market growth – A rising market can benefit all stocks, even if individual companies don’t see specific growth.
• Mergers and acquisitions – these can boost a company’s profile and equities.

Besides capital appreciation, investors can draw dividends from their shareholding. Dividends are portions of the company’s profits paid out per share held, usually on a periodic basis, mostly quarterly or annually. While not all companies pay dividends, those that do can offer investors a steady income stream.

That said, remember investing in shares involves risk. The stock market can be volatile, and you could lose some or all of your investment. Therefore, it’s important to diversify to mitigate your risk. Moreover, research before committing your funds and have a long-term perspective, as investing in stocks is not a get-rich-quick scheme.

How Can You Invest in Stocks?

The first stage in stock investments is educating yourself about them. Learn about the different kinds of equities, how the stock market works, and factors affecting stock prices. Additionally, assess your risk profile, understanding that while there is potential for profit, there is also the possibility of losses.

Secondly, you must choose an investment approach. You may opt for DIY investing, for instance, making the investment decisions yourself. Alternatively, you may opt for Robo-advisors that use algorithms to automate your investment options. Lastly, you may choose financial advisors who guide you in building and managing your portfolio.

From there, you must choose a brokerage firm. Some factors in making that decision include their fees, features, and ease of use. Again, consider factors like minimum investment, commission structures, and their research tools. Lastly, decide on what you want to invest In. It could be individual stocks, Exchange-traded funds (ETFs), or Mutual funds. 

Choosing Your Investment Path: Individual Stocks, Mutual Funds, and ETFs Demystified

An Individual stock is a security representing partial ownership of a specific company. Holding it grants you direct ownership of that firm, meaning you have a claim to its profits and assets. You may even hold voting rights. This investment vehicle promises high returns at equally high risk.

Mutual funds, on their part, pool funds from different investors and invest them in a diversified portfolio of securities. Managed by fund managers, these professionals allocate the funds to maximize investors’ profits. Mutual funds serve as effective tools for diversification and are readily accessible as they charge less fees than individual shares.

Like mutual funds, exchange-traded funds (ETFs) are pooled investments. The only difference is that they trade on a stock market. These passive investment vehicles track a particular index or market sector, offering investors diverse investment options.

What are the Different Stock Types?  

There are many different ways of categorizing stocks, but some of the most common classifications are:

Based on ownership rights

Depending on shareholder rights, we can have two types of stocks: common stocks and preferred stocks.

• Common stocks: Besides giving you ownership rights, common stocks confers voting power proportional to the number of shares held.
• Preferred Stocks: These offer you dividends but don’t come with voting rights. The trade-off is that holders are prioritized over ordinary shareholders in dividend payouts. Equally, they have a higher claim to the company’s assets in case of a liquidation. 

Based on market capitalization

Depending on the market capitalization of the company you are investing in, you can have three kinds of stocks:

• Large-cap stocks – issuing companies have a capitalization of over $10 billion.
• Mid-cap stocks – issuer has a market cap of $2 billion to $10 billion.
• Small-cap stocks – are accompanied by a market capitalization of $250 million to $2 billion.

Investment style:

These stocks fall into one of two categories:

• Growth stocks – investors bank on these companies growing faster than the market average. One of their striking features is that they don’t pay dividends. That’s because their issuers plow back profits to hasten growth. Investors, therefore, can only make money from them in the long term through capital gains.
• Income/ dividend stocks – are offered by companies that pay out a high percentage of their profits as dividends. These dividends can come in either of two ways: cash or additional stock. Again, the payouts are periodic, with many companies making them quarterly or annually.

By Industry:

These derive their name from the economic sectors they serve, such as:

• Technology stocks: Companies that develop or sell technology products or services.
• Healthcare stocks: Companies that develop or sell healthcare products or services.
• Financial stocks: Companies that provide financial services like banks and insurance companies.

Who Can Own Stocks?

Generally, anyone can own stocks. Any citizen of a given country of legal age can open brokerage accounts and purchase stocks. In the US, for example, the minimum age is 18. However, a custodian can manage a custodial account for minors.

Institutions like corporations, retirement plans, trusts, and endowments can also own stocks. Even non-residents can invest in equities abroad, although they may face extra regulations and restrictions.

As mentioned earlier, persons yet to attain the legal age cannot trade on the stock market. Likewise, individuals deemed mentally incompetent or under legal guardianship may have limitations on their ability to own stocks.

Citizenship and residency can also hinder one’s ownership of shares. Some countries may restrict non-residents from investing in their stock markets. Moreover, different account types, e.g., retirement accounts, may limit who can participate. 

Why Should I Own Stocks?  

Deciding whether to own stocks depends on your circumstances and financial goals. Here are some potential benefits and drawbacks to consider, starting with the benefits:

• Growth potential – Over the long term, stocks can offer higher returns than other investments, such as savings accounts. This can help you grow your wealth and achieve your financial goals.
• Inflation protection – Stocks can help protect your purchasing power against inflation, as their value tends to rise along with the cost of living.
• Income generation – Some companies pay dividends to their shareholders, providing you with a regular income stream.
• Ownership and voting rights – As a shareholder, you own a small piece of a company and have the right to vote on certain decisions. This can give you a sense of ownership and involvement in the company’s success.
• Diversification – Owning stocks can help diversify your portfolio and reduce overall risk. This is because stocks correlate less with other asset classes like bonds or real estate.

However, you may have to contend with the following drawbacks:

• Risk – Share prices can fluctuate significantly in the short term, and you could lose money on your investment.
• Time commitment – Investing in stocks requires research and ongoing monitoring.
• Transaction costs – Costs associated with buying and selling stocks, such as commissions and fees, can affect your returns.
• Emotional impact: The ups and downs of the stock market can be emotionally draining for some people.

Stocks & IPOs Explained  

An Initial Public Offering (IPO) is a defining moment for any company. It’s when a private firm sells shares of its stock to the public for the first time. This process converts it from private ownership to public ownership, helping it to raise new capital for growth and expansion. IPOs follow a three-stage process: 

Pre-IPO stage:

• The company undergoes a rigorous process of preparing for public scrutiny, including financial audits, legal compliance, and investor presentations.
• Investment banks act as underwriters, helping the company set the initial price of its shares and marketing them to potential investors.
• Institutional investors like mutual and hedge funds get the first chance to buy shares during a “book building.” Book building is the process of an underwriter determining the IPO price.

IPO Day:

• The company’s shares begin trading on a stock exchange, usually with a symbolic opening bell ceremony.
• The initial price of the shares may fluctuate significantly depending on investor demand and market conditions.
• Retail investors, like individuals, can then start buying shares through their brokerage accounts.

Post-IPO stage:

• The company becomes subject to ongoing public reporting requirements and increased scrutiny from analysts and investors.
• It continues to operate and hopefully grow, with the capital raised from the IPO fueling its future projects and strategies.

IPOs are essential to a company because they help it: 

• Raise capital
• Increase brand awareness
• Enhanced liquidity

Stocks vs Bonds: What’s the Difference?

Stocks and bonds have different characteristics and cater to different investment goals. Here’s a breakdown of their fundamental differences:

Nature

Stocks represent ownership in a company. When you buy them, you become a shareholder and own a small piece of the company. On the other hand, bonds (debt securities) represent a loan to a company or government. When you buy a bond, you lend money to the issuer and receive interest payments in return. 

Returns and Volatility

Historically, shares offer higher potential returns than bonds. However, they also experience greater volatility. In contrast, Bonds typically provide lower returns than stocks but have greater stability and predictability.

Investment Time Horizon

Stocks are best suited for long-term investments due to their potential for growth and ability to ride out market fluctuations. However, depending on your needs, bonds can serve short-term and long-term investment needs.

Liquidity

Equities are more liquid than bonds, meaning you can trade them more easily. However, some stocks may be less liquid, especially in smaller companies. Bonds can be less liquid than stocks, especially longer-term bonds.

Conclusion/ Wrapping Up  

Understanding stocks is not just a financial literacy milestone. It’s a gateway to building wealth and financial security. As you journey through stock ownership, remember knowledge is your greatest asset. Continuous learning and cultivating a diverse portfolio are the keys to seeing your investments grow.

FAQs

Here are answers to some frequently asked questions.

What does it mean to buy a stock on margin?

Buying a stock on margin means borrowing money from your broker to purchase a stock. You put up a portion of the stock’s price as collateral, and the broker loans you the rest. This allows you to leverage your investment and potentially amplify your returns. However, it also heightens your losses if the stock price goes down.

What does it entail to own stock in a company?

Owning stock in a company means you are a partial owner of that company. You have a claim on the company’s assets and profits and may also have voting rights on certain company decisions. As a shareholder, you can benefit from the company’s growth through dividends and capital appreciation (an increase in the stock price).

What does it mean to “hold” in stocks?

“Holding” a stock simply means owning it without selling it. You can hold a stock for as long or as short as you like. Some investors keep stocks long-term, hoping to benefit from the company’s long-term growth, while others may keep stocks for shorter periods, hoping to profit from short-term price movements.

What does it mean to have vested stocks?

Vested stocks are stocks you have earned or been granted but can only access or sell once a certain vesting period has passed. Companies often use vesting periods to incentivize employees to stay with them for some time. You can keep those stocks once the vesting period ends.

What is an individual stock?

An individual stock is a security that represents ownership in a single company. Millions of individual stocks are available to trade on stock exchanges worldwide. Each stock has its unique ticker symbol and price.

What’s the difference between a share and a stock?

A share is a unit of ownership in a company, while a stock is the security that represents that ownership. You can think of a share as a piece of pie and a stock as the whole pie. Each slice of the pie (share) represents ownership across the entire pie (stock).