What is a stock?
Points to know
- If you buy a company's stock, you become a part owner and you'll generally make money if the company does well—or lose money 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 have less room for growth.
Why buy stocks?
When people talk about investing in stocks, they're usually referring to common stock. These kinds of stocks give you the opportunity to join in the success of public companies, and as such, they're an investment that can really grow your portfolio.
Because you're a part owner of the company that issues your stock, it's pretty simple: For the most part, when the company makes money, you make money. (Conversely, of course, when the company loses money ... well, you get the picture.)
There are a couple of ways you'll see this part-ownership reflected.
First, the price of each share of stock can increase in value. If you buy 50 shares at $10 a share and then the share price increases to $15, you're now $250 richer.
The company can also choose to issue a dividend to shareholders. Say the issuer of your 50 shares of stock announces a $2 dividend. That means you'll be paid $100 (which you can use to buy more shares, if you wish).
An investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
The sum total of your investments managed toward a specific goal.
The distribution of the interest or income produced by a fund's holdings to its shareholders, or a payment of cash or stock from a company's earnings to each stockholder.
GOOD TO KNOW
Over shorter periods of time (weeks or months), the value of a particular stock can fluctuate based on a lot more than the actual performance of the company.
For example, if investors think the company could be headed for tough times—because a competitor releases a new product or because the company hasn't been growing as fast as everyone expected, for example—the stock price may go down. On the other hand, potential good news about a company can push the stock higher—even if nothing has actually changed.
And of course, the overall performance of the economy and markets will affect a stock's price, too.
But over the long term, the main determinant of a stock's performance is how successful the underlying company has actually been.
There are several ways to categorize stocks.
Growth & value
Companies generally fall into 1 of 2 categories depending on how they make money for their investors.
Growth companies are in an expansion phase. Any available money they have is likely to be funneled toward the expansion of their businesses or the development of new products and services. As they grow, the value of their shares increases.
Value companies are relatively established. While they may still be growing, there's not as much room for the kind of rapid expansion that growth companies pursue. So rather than plow all their cash flow into opportunities for development, these companies are more likely to pay dividends.
Companies can also be divided up based on the total value of their shares—their "capitalization." Stocks are generally considered to be large-, mid-, or small-cap, although at the extremes you may also see references to mega-cap or micro-cap stocks.
The boundaries between one grouping and the next aren't firm, and they change as the overall market value changes. In general, large-cap stocks make up about 65% to 75% of the entire market, and mid- and small-cap stocks about 10% to 15% each.
The stocks of large-cap companies tend to be more stable than those of smaller companies. But smaller companies may have more potential for growth.
Companies can also be grouped by sector. As with capitalization, there are several different sector classification systems. Most systems include categories like technology, health care, and energy.
Stocks within particular sectors will tend to react in predictable ways to economic conditions, so it's important to make sure your investments don't get too concentrated in specific sectors, unless you're doing it intentionally as part of your investment plan.
For example, when the economy is doing poorly, sectors like information technology, consumer discretionary, and telecommunication services may suffer because people can choose to spend less in these areas.
On the other hand, people must keep spending on things like consumer staples, utilities, and health care, so these sectors may be less affected.
It's also important to note that good or bad news about a company's stock may affect other companies within that sector to some degree.
Here's one sample classification system and the types of companies that would fall under each.
Companies that manufacture products and provide services considered to be nonessential.
- Apparel, textiles (Nike, Inc.).
- Food service, lodging (McDonald's Corporation, Marriott International, Inc.).
- Household furniture, appliances (Williams-Sonoma, Inc., Whirlpool Corporation).
- Leisure-related (The Walt Disney Company, Brunswick Corporation).
- Printing, publishing (The McGraw-Hill Companies, Inc.).
- General retail (Target Corporation).
Companies providing direct-to-consumer products that, based on consumer purchasing habits, are typically considered nondiscretionary.
- Food products (Campbell Soup Company, Archer Daniels Midland Company).
- Beverages (The Coca-Cola Company, Anheuser-Busch Companies, LLC).
- Soaps, toiletries (The Procter & Gamble Company, Colgate-Palmolive Company).
- Tobacco (Altria Group, Inc., Reynolds American Inc.).
Companies involved in the exploration and production of energy products, such as oil, natural gas, and coal.
- Oil and gas drilling (Helmerich & Payne, Inc.).
- Integrated oil and gas (Marathon Oil Company, Exxon Mobil Corporation).
- Consumable fuels (Arch Coal, Inc., Peabody Energy, Inc.).
Companies that provide financial services.
- Banks (Bank of America Corporation, Wells Fargo & Company).
- Consumer finance services (American Express Company, SLM Corporation).
- Insurance (The Allstate Corporation, MetLife, Inc.).
Companies involved in providing medical or health care products, services, technology, or equipment.
- Pharmaceuticals (Bristol-Myers Squibb Company, Merck & Co., Inc.).
- Biotechnology research and production (Amgen Inc., Biogen Inc.).
- Medical supplies and services (Medtronic plc, Boston Scientific Corporation).
- Managed health care (Aetna Inc., Cigna Corporation).
Companies that convert unfinished goods into products used to manufacture other goods or provide services.
- Aerospace and defense (Lockheed Martin Corporation, Northrop Grumman Corporation).
- Machinery (Caterpillar Inc., Ingersoll-Rand plc).
- Industrial conglomerates (3M Company, General Electric Company).
- Airlines (AMR Corporation, Southwest Airlines Co.).
Companies that serve the electronics and computer industries or that manufacture products based on the latest applied science.
- Computers and hardware (Dell Inc.).
- Software (Microsoft Corporation, Intuit Inc.).
- Internet services (Yahoo! Inc., Google Inc.).
- Networking (Cisco Systems, Inc.).
- Semi-conductors (Intel Corporation, National Semiconductor Corporation).
Companies that extract or process raw materials.
- Chemicals (The Dow Chemical Company).
- Metals and mining (Alcoa Inc., Newmont Mining Corporation).
- Paper (International Paper Company).
Companies that provide phone, data-transmission, cellular, or wireless communication services.
- Diversified phone services (Verizon Communications Inc., AT&T Inc.).
- Wireless (Sprint Corporation).
Companies that distribute electricity, water, or gas, or that operate as independent power producers.
- Gas (Piedmont Natural Gas Company, Inc.).
- Electricity (Exelon Corporation).
- Water (Southwest Water Company).
- Power (Energy Future Holdings Corporation).
DOMESTIC OR INTERNATIONAL?
Companies can also be divided based on where they're headquartered. The U.S. market makes up only about half of the world's opportunities for stock investing.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
ETF (exchange-traded fund)
A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.
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*Source: Donald G. Bennyhoff and Francis M. Kinniry Jr., 2016. Vanguard Advisor's Alpha®. Valley Forge, Pa.: The Vanguard Group.
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.
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