By Randy Neumann
When you buy company stock, you’re actually purchasing a share of ownership in that business. The greater the number of shares you own, the higher the percentage of ownership you have in that company. Investors who purchase stock are known as the company’s stockholders or shareholders.
Your percentage of ownership in a company also represents your share of the risks taken and profits generated by the company. If the company does well, your share of the total earnings will be proportionate to how much of the company’s stock you own. The flip side, of course, is that your share of any loss will be similarly proportionate to your percentage of ownership, though you are not personally financially responsible for any share of the liabilities of the company in which you hold an equity interest.
Beyond that, depending on the company and the types of shares you have, stock ownership may carry other benefits. Specifically, you may be entitled to dividend payments (which you can generally receive either in cash or additional shares), capital gains payouts, voting rights, and other corporate privileges. For example, common stockholders have the right to vote for candidates for the board of directors and on other important issues.
If you purchase stock, you can make money in one of two ways. First, corporate earnings may be distributed in the form of dividends, usually paid quarterly. Secondly, you can sell your shares. If the value of the company’s stock has increased since you purchased it, you will make a profit. Of course, if the value of the stock has declined, you’ll lose money.
Stock is commonly categorized by the market value of the company that issues the stock. For example, large-cap stocks describe shares issued by the largest corporations. Other general categories include small-cap, mid-cap, and micro-cap.
Stock is also commonly classified according to the characteristics of the company and/or the expectations of investors. For example: Growth stocks, aka “glamour” stocks, are usually characterized by earnings that are increasing at a faster rate than their industry average or the overall market. These are often in new or fast-growing industries and frequently have the potential to give shareholders returns greater than those offered by the stocks of companies in older, more established industries. However, growth stocks are among the most volatile classes of stock and have significant risk for losses.
Value stocks are typically characterized by selling at a low multiple of a company’s sales, earnings, or book value. An example would be: Occidential Petroleum OXY.
Income stocks generally offer higher dividend yields than market averages and typically fall into the utility and financial sectors, as well as other stable and well-established industries.
Blue chip stocks are the stocks of large, well-known companies with good reputations and strong records of profit and growth. They also generally pay dividends.
Also worth mentioning are American Depositary Receipts (ADRs) that are negotiable instruments created to represent shares of stock (and sometimes bonds) in non-U.S. companies.
The advantages and disadvantages of investing in stocks depend largely upon the stock or type of stocks that you choose.
In general, stocks offer a greater potential for returns than do bonds or cash equivalents. Historically, this has been particularly true over the long-term periods. With stock, you actually own a share of the company and therefore have ownership rights, which may include voting rights. You can invest in stock that has a history of paying regular dividends; you can also invest in stock that has the potential to appreciate significantly in value. And, stock is easy to buy and sell.
Of course, if the company you invest in performs poorly; it may not pay dividends, even if it had regularly paid dividends in the past. More importantly, though, poor performance may result in your shares losing value. In fact, your shares can lose value simply because they’re subject to the general volatility of the stock market, which has experienced sharp declines in the past. This volatility means that your risk of losing principal is greater with stock than it is with bonds and cash equivalents. It also means that stocks may not be appropriate for shortterm investment timelines.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities and insurance offered through LPL Financial. Member FINRA/ SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.