Whenever I talk to anyone about investing it very quickly goes into me talking about stocks. I then have to spend the next 5 to 10 minutes telling people buying stocks is not gambling. For a long time I struggled to change people’s strongly held opinions on this topic. Then I changed up my strategy. I used to talk about the resilience of the market, how it always bounces back even through the worst times. This argument didn’t convince many people because just like every generation we think our problems will be the one to end civilization as we know it. Instead of talking about those points I started teaching people what stocks actually were. I have condensed about 15 minutes of me talking (I tend to go on tangents) into 4 key takeaways. So before I lose your interest here they are…
Why do stocks exist?
People hear about the stock market all the time, but how many people actually know why stocks even exist? The reason a company will sell a stock is to raise money for future projects that they expect to raise future profits. The reason companies want their stock to go up in value is because this allows them to make more money off future sales of their stock that they still own.
What happens when I own a stock?
When you own a stock you get the rights to dividends the company pays and you get to vote in annual shareholder meetings. I’m sure some people read that and are now asking what are dividends and what is a shareholder meeting? A dividend is a quarterly payment a company gives its shareholders. Not every company pays a dividend. A shareholder meeting is where shareholders vote on the Board of Directors and specific issues facing the company. The Board of Directors is responsible for increasing the value of the company and usually appoints CEO’s. The more shares you own the more votes you have at these meetings. These are physical meetings but not every shareholder is at them but every shareholder has a vote. By voting shareholders are able to influence the direction of a company.
How do you make money owning stocks?
The primary reason people buy stocks is to make money. There are two ways people make money through owning stocks: dividends and an increase in stock price. Dividends like I said earlier are a quarterly payments that companies pay to their shareholders. The amount a company pays depends a lot on their financial situation. Usually the more profitable a company the more likely they are to pay dividends because they have the money to do so. However, not all profitable companies pay dividends. Some profitable companies instead of paying dividends will use this money instead to reinvest and continue to grow their company.
The other way people make money in owning stocks is when they sell shares of the stock at a price that is higher than what they bought it at. This is a riskier way to make money on stocks versus just collecting dividends payments, but the risk does also lend itself to potentially better rewards.
What causes a stock price to change?
This next part is usually what causes the most apprehension about stocks. I am going to go over what causes a stock in the long-term to go up or down. When I talk about long-term I am talking about over say 5 to 10 years. What causes a stock to go up or down in the short-term is incredibly tough to predict. So be very weary of anyone who promises short-term success in stocks, because predicting short-term price changes is very tough.
Growth. This is pretty simple and pretty intuitive. Companies that are growing will generally experience a growing stock price. When I say growing this doesn’t necessarily mean growing profits, it can also be growing revenue, market share, cash flow, etc. There are examples of companies that are not profitable, but have seen amazing stock price growth. Think Amazon, it started trading in 1997 at $1.50 a share and did not record a profit until 2003 but by then the stock was trading at nearly $40!
When a company stops growing the stock will usually start heading in a downward direction. Usually what causes a company to stop growing is that it has increased competition, it is not innovating or sometimes it has reached market saturation and doesn’t have room to grow. Once this happens to a company they will usually increase their dividend to keep investors around. Good dividends will usually keep the stock price of a non-growing company from falling too low.
I know this was a lot but I do hope after reading this you have a better understanding of what stocks actually are. I think the most important and most underrated part of investing is understanding how it actually works. If you liked this article and you want more like it let me know at firstname.lastname@example.org!