What is a stock?
What is a stock?
Points to know
- When you buy a company's stock, you become a part owner. You may benefit financially if the company succeeds—or face losses if it doesn't.
- Depending on how established the company is, most of the money you make will come either through increases in share price or through dividend payments.
- Larger companies tend to be more stable than smaller companies, but they also offer less growth potential.
See if stocks are a good fit for your investment portfolio.
Why invest in stocks?
When people talk about investing in stocks, they're usually referring to common stock. These investments let you share in the success of publicly traded companies—with the potential to grow your portfolio with them.
When you purchase stock, you become a part owner of that company. If the company performs well, your investment may increase in value. Conversely, if the company performs poorly, your investment may decline in value.
This ownership can benefit investors in two primary ways.
Appreciation
When the price of each share of stock increases in value, the total value of your investment grows. For example, if you purchase 50 shares of stock at $10 per share and the price rises to $15 per share, your investment increases by $250.
Dividends
Some companies share a portion of their profits with shareholders through dividends. If a company announces a $2 dividend per share, you would receive $100 for your 50 shares. You can take the payout as cash or reinvest your dividends to purchase more shares, potentially boosting your long-term returns.
However, not all companies pay dividends. Many growing companies choose to reinvest their profits back into the business instead.
How do stocks work?
Stock prices change from day to day, and often for reasons beyond a company's actual performance. Market trends, economic conditions, and even news headlines can cause a stock's price to move up or down.
For example, if a competitor releases a new product or a company's growth slows, investors may grow concerned and the stock price may dip accordingly. On the other hand, strong earnings or positive industry developments can boost investor confidence and push prices higher.
While short-term fluctuations are common, a stock's long-term performance is typically tied to the underlying company’s financial strength and ability to grow. Over time, financially sound companies may deliver more stable returns, even though short-term stock prices may still fluctuate.
Understanding the stock market can help you make better investment decisions.
Key factors to consider when choosing stocks
When choosing a company to invest in, it's important to look closely at the fundamentals, like the company's financials, leadership, and competitive position, along with broader industry trends. These factors can help you assess potential risks and long-term opportunities—and make more informed choices.
This process is known as fundamental analysis, and it typically includes:
How to determine if stocks are the right investment for you
Stocks can be a powerful investment option with the potential for higher long-term returns, but they can also carry more risk. Before investing, it's important to consider how that risk aligns with your goals and tolerance.
If you're comfortable with market ups and downs—and have a longer timeline—individual stocks may be a good fit. If you're aiming for a more predictable income stream, a lower-risk option like bonds may better suit your needs.
If you do decide to invest in stocks, understanding how they're categorized can make it easier to align your investments with your strategy. Stock classifications highlight key characteristics and market trends.
Here are some of the most common categories of stocks:
Growth vs. value stock
Most stocks fall into one of two broad categories based on how they generate returns for investors:
- Growth stocks are shares of companies in an active expanding phase. They typically reinvest earnings in product development and growth, which may lead to higher long-term returns. However, they usually come with more price volatility and less emphasis on dividends.
- Value stocks, on the other hand, represent more established companies with steady performance. These stocks often trade below value, offering potential for price appreciation as the market adjusts. Value companies also tend to return profits to shareholders through regular dividend payments.
Stocks by market capitalization
Stocks are also commonly grouped by the total value of a company's outstanding shares, known as its market capitalization. “Market cap” is a key measure of company size and potential risk and return.
Stocks typically fall into one of three categories:
- Large-cap: Market value over $10 billion; more stable, with consistent earnings and lower volatility.
- Mid-cap: Market value between $2 billion and $10 billion; provide a balance between growth and stability.
- Small-cap: Market value under $2 billion; higher growth potential with greater short-term swings.
At the extremes, you may also see mega-cap (over $200 billion) and micro-cap (under $300 million) stocks.
Sector-based stocks
Stocks can also be grouped by sector, based on the type of business a company operates. Each sector responds differently to economic shifts. For example, sectors like consumer discretionary or communication services may be more sensitive to downturns, since people tend to cut back on nonessential spending. But utilities, health care, and consumer staples often remain more stable because they're essential.
Unless it's part of your overall strategy, it's typically best to avoid overconcentrating your investments in a single sector. Diversifying your portfolio is an important part of managing your risk. Sector-based mutual funds and sector-based ETFs can help you target specific parts of the market while maintaining diversification.
Here's a sample classification system and the types of companies that would fall under each sector.
Companies that manufacture products and provide services considered to be nonessential.
Examples:
- Apparel, textiles
- Food service, lodging
- Household furniture, appliances
- Leisure-related
- Printing, publishing
- General retail
Companies providing direct-to-consumer products that, based on consumer purchasing habits, are typically considered nondiscretionary.
Examples:
- Food products
- Beverages
- Soaps, toiletries
- Tobacco
Companies involved in the exploration and production of energy products, such as oil, natural gas, and coal.
Examples:
- Oil and gas drilling
- Integrated oil and gas
- Consumable fuels
Companies that provide financial services.
Examples:
- Banks
- Consumer finance services
- Insurance
Companies involved in providing medical or health care products, services, technology, or equipment.
Examples:
- Pharmaceuticals
- Biotechnology research and production
- Medical supplies and services
- Managed health care
Companies that convert unfinished goods into products used to manufacture other goods or provide services.
Examples:
- Aerospace and defense
- Machinery
- Industrial conglomerates
- Airlines
Companies that serve the electronics and computer industries or that manufacture products based on the latest applied science.
Examples:
- Computers and hardware
- Software
- Internet services
- Networking
- Semiconductors
Companies that extract or process raw materials.
Examples:
- Chemicals
- Metals and mining
- Paper
Companies that provide phone, data-transmission, cellular, or wireless communication services.
Examples:
- Diversified phone services
- Wireless
Companies that distribute electricity, water, or gas, or that operate as independent power producers.
Examples:
- Gas
- Electricity
- Water
- Power
Domestic vs. international stocks
Stocks can also be categorized by where a business is headquartered. Domestic stocks are shares of companies in your home country. International stocks are shares of companies outside your home country.
Investing in international stocks helps diversify your portfolio, reduce dependence on a single economy, and give you access to growth opportunities across different regions. While U.S. companies make up a large portion of the global market, they don’t account for all the investment opportunities worldwide.
Common vs. preferred stocks
Stocks are typically issued as either common or preferred. Each has unique characteristics that make them suitable for different types of investors.
Common stock is the most widely held type of stock. It represents ownership in a company and typically includes voting rights on key corporate matters. Common shareholders may receive dividends, but payments are not guaranteed and are issued only after preferred shareholders are paid. Common stocks tend to be more volatile, but also offer greater potential for long-term growth.
Preferred stock typically does not include voting rights but offers other advantages. Preferred shareholders typically receive fixed-rate dividends—paid before any dividends are issued to common shareholders—and have a higher claim on company assets in the event of liquidation. Preferred stocks may appeal to investors who prioritize a more stable income stream and are comfortable with more modest growth potential.
Dividend stocks
Dividend stocks are shares of companies that regularly distribute a portion of their profits to shareholders in the form of dividends. These payments are typically made on a quarterly basis and can offer a reliable source of income.
Dividends can help reduce the impact of market volatility by providing consistent returns, even when stock prices are flat or declining.
Companies that pay dividends are often more established and financially sound, but not all dividend stocks are created equal. It is important to evaluate a company's financials, payout ratio, and history of maintaining or growing its dividends over time.
Dividends and income from stocks
When you invest in stocks, you can earn income in two primary ways: through capital gains or through dividends.
Capital gains occur when the value of a stock increases and you sell it for more than you paid. This type of income depends on the performance of the stock and overall market conditions.
Dividends, on the other hand, are typically paid in cash, though some companies offer them in the form of additional shares. While dividend stocks regularly distribute their profits, some companies prefer to reinvest their profits back into the business to fuel growth.
As with all earnings, you will have to pay taxes on dividend income. Your tax rate will depend upon various factors, including your tax bracket and how long you've held the stock. Qualified dividends are taxed at the lower long-term capital gains rate, while ordinary dividends—also known as nonqualified dividends—are taxed at the higher income tax rate.
Diversifying with stocks
Spreading your investments across a variety of companies, sectors, and regions—rather than a single stock or a handful of stocks—helps reduce risk and makes it less likely that a single company or sector will significantly impact your overall performance. Portfolio diversification can't eliminate risk entirely, but it can help create a more stable investment experience over time.
You can diversify your stock holdings in several ways:
- By sector: Invest across different industries, such as technology, health care, and energy.
- By market cap: Include a mix of large-, mid-, and small-cap stocks.
- By geography: Combine domestic and international stocks across global markets.
One of the simplest ways to gain built-in stock diversification is through mutual funds or ETFs, These professionally managed funds can hold hundreds—or even thousands—of individual stocks based upon their categories. Designed to track broad market indexes, they bring diversified exposure in a single investment.
What's next?
Whatever your financial goals—whether you're new to investing or looking for expanded options—Vanguard is here to support you on your journey.
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All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.
Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.