What are Stocks?
Stocks allow traders to buy a share in ownership of a publicly-listed company.
What are stocks?
A stock in financial trading refers to publicly-listed companies on any given stock exchange across the globe. When a company or corporation chooses to list on a stock exchange, it allows the public to buy a share in ownership. The share – or asset – is known as a stock. It’s an equity investment and one of the most popular financial trading instruments in the world. Because a stock represents a share in the company, people who own these shares have certain rights. For example, they can vote at the company’s AGM on important matters and receive dividends on company profits.
Stocks can be categorised into industries based on what the company does. For example, banks are categorised as ‘financial’ stocks and companies such as Facebook and Apple are categorised as ‘technology’ stocks. A ‘Global Industry Classification Standard’ (GICS) was created to standardised industry sectors across all stock exchanges. Investors can buy or sell multiple stocks. This means they can own banking, healthcare and energy stocks. Stocks refer to the ownership of one or more companies or a group of companies within an industry class (i.e. owning technology stocks). Shares, however, refer to a specific company. For example, an investor might own 100 ‘shares’ in Facebook. Therefore, Facebook is the stock and the individual units are shares. But more often then not, the two terms ‘stocks’ and ‘shares’ are used interchangeably in trading.
Types of stocks?
There are two main types of stocks issued by a company to its investors. Both types of stocks are available on an exchange and both represent a share in ownership.
Most investors opt for a common stock. A common stock allows shareholders to vote on corporate issues such as company directors and remuneration. Common stock investors also benefit from company profits through rising share prices and variable dividend payments. Common stock essentially gives investors more control over the company, however if the company does not make a profit, common shareholders could miss out on a dividend payment. Another downside to common stock is higher risk. If the company goes bankrupt, creditors, bondholders and preferred shareholders are paid out before common shareholders. Being last in line for payment means common shareholders are unlikely to get their money back.
Investors who opt for preferred stocks are choosing security and certainty. Preferred stocks set predetermined dividends and are paid at regular intervals, regardless of the company’s performance. As a result, preferred stocks generally trade at a more stable price. There are upsides and downsides to this. For example, if the company’s performance exceeds expectations and it chooses to increase its dividend payment, preferred stock holders miss out. Preferred stock holders are also not given voting rights and have no control over company management. The company can choose to buy back preferred stocks at any time and any set price.
Preferred stocks can sometimes be referred to as hybrid securities because of their similarities to bonds and fixed dividend payments. One of the key differences between a bond and a preferred stock is that the company can choose not to pay preferred stock holders a dividend. So, while preferred stock holders are given preference over common stock holders, there’s still no absolute security.
What are blue-chip stocks?
Blue-chip stocks are the shares of major, multinational companies listed on any given exchange. The stocks belong to the biggest and most valuable companies with strong financial structure. ‘Blue chips’ usually have a long-history on the exchange with stable earnings and strong performance. Because of these traits, blue chip stocks are generally highly-priced. The company itself is usually a household name with a market capitalisation in the billions, and therefore blue chips are seen as stable investments by traders. Major banks for example, are usually blue-chip stocks. In Australia, mining giants Rio Tinto and BHP Group are considered blue-chip stocks as well as supermarkets Coles and Woolworths.
Why do companies issue stocks?
Companies issue stocks for one simple reason: to make money. They raise funds through an initial public offering (IPO), then use the funds to reinvest in the business, expand, and make more money. By listing on an exchange, a company is choosing to move from private ownership to public ownership and pay profits to shareholders in the form of dividends.
Why do people buy stocks?
Just like investing in property, people buy stocks as a form of investment. Stocks are purchased in the hope the company will increase in value and repay shareholders with dividends from its profits. Even if a company chooses not to pay dividends, if the share price goes up, investors will still make money by selling the shares. For example, if an investor buys company shares for $1 and the value increases to $3 per share, the investor has made three times their initial investment. However, if the company’s profits sink, and the shares fall to 50 cents per unit, then the investor will lose half of their initial profit.
Benefits and risks of investing in stocks?
Before we start, there are pros and cons to any financial investment whether its stocks, property, forex or CFDs.
Benefits of investing in stocks include:
- Partial ownership of a company
- Profiting from an increasing share price
- Passive income from dividend payments or franking credits
- Easy to buy and sell
- Low costs compared to property investments
Risks or disadvantages of buying stocks include:
- No guarantee the company will pay dividends
- Market volatility could send the share price lower
- If the company goes broke, you could lose your investment
- Time consuming
How to buy and sell stocks?
The most common way for retail investors to purchase stocks is through a broker or brokerage service. You can choose an online brokerage service and open an online trading account yourself or opt for a full-service broker. A full-service broker provides advice on which stocks to buy and sell, whereas an online service requires you to do all the research yourself.
Occasionally companies adopt a Direct Stock Purchase Plan (DSPP), where investors engage directly with the company to purchase stocks, but more often then not, a broker is required.
What are the fees involved to trade stocks?
When buying and selling stocks, a fee or commission is charged by the broker. Each broker is different so it’s important to research brokers and the level of support or service you need. A full-service broker is more expensive than an online service because you’re paying for advice and a personalised service.
Brokerage fees are usually a percentage of your investment, whether you are buying or selling stocks. For example, the commission of an investment up to $5,000 could be 2.5%. The more money invested, the lower the percentage. Most brokers have a minimum fee that is charged if the investment is relatively low.
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