What are stocks?

• Level: For beginners
• Reading duration: 5 minutes

Stocks and their price

A stock is a tradable financial asset that entitles you to a share in the future growth of a particular company plus any dividends paid. The value of a stock directly reflects the market’s view of its associated firm’s prospects. For example, if you own £100 of Apple stock and its price rises 10%, then your holding will now be worth £110. Similarly, if the stock then sheds 10%, your account will show that your Apple shares are now worth £99. Stocks are typically traded on public stock exchanges such as the NYSE in the US, the Frankfurt stock exchange, and Euronext Paris. A stock’s current price is the aggregate of the buy and sell decisions of all market participants who are trading it at any given time. The price is subject to constant change as the market continually assesses the stream of news and events that can impact upon a firm’s fortunes. Factors that move stock prices include:

• Company news such as results, profit forecasts, personnel changes, product announcements, expansion plans, takeovers and mergers
• Competitor firm activity
• Economic conditions
• Government action or regulation that impacts upon the firm or industry
• Geopolitics

New information is absorbed and reflected in stock prices at lighting speed. Anticipated events will have already been ‘priced in’ by the market and won’t make much difference. But unforeseen events can have a dramatic impact. For example, the realisation that Covid was a global pandemic crushed the travel industry but utterly transformed video comms stocks such as Zoom for a time.

Purchasing stocks

Shares are typically bought electronically through a broker and may be traded whenever the stock exchange upon which they’re listed is open. Transparent pricing and liquidity is a much underestimated advantage of stock investing. You almost always know what your stocks are worth and can trade them whenever the market is open. Contrast that with more esoteric investments such as jewellery, wine, or art. Such items can be hard to sell quickly and their true value difficult to determine. The advantage often lies with highly knowledgeable specialists in these markets precisely because prices aren’t transparent. Stock ownership can also confer other benefits such as voting rights, the right to attend a company’s annual general meeting and so on. However, it’s the prospect of long-term capital appreciation and regular dividend payments that make stocks valuable to most investors.

Dividends

Dividends are cash payments made by a firm to its shareholders on a per share basis. For example, a firm may announce a dividend of £0.25 per share. If you own 1,000 shares, then you’ll earn £250, paid directly into your brokerage account. The money is yours to do with as you please. You can reinvest it (recommended), or withdraw and spend it (more fun). Most companies follow a regular dividend schedule, typically paying out annually, half-yearly, or quarterly. However, dividends are not guaranteed. Distributions are made from company profits and so vary depending on the firm’s performance. If a company runs into difficulties then it may suspend its dividends completely. Some companies do not pay a dividend. Young, fast-growing companies often fall into this camp. Usually that’s because the firm’s management believes they can put the cash to better use by investing in the growth of the firm – perhaps by developing new products, acquiring a rival, entering new markets, or hiring more employees. In this case, shareholders hope to be rewarded by capital appreciation later, rather than dividend payments now.

Stock diversification

The excellent long-term track record of stocks makes this asset class the growth engine of most investment portfolios. However, diversification is absolutely vital. That’s because corporate history is littered with the bones of former giants that fell victim to the forces of creative destruction. Think of the universe of stocks as an ecosystem. It’s a web of diverse companies that range across many different niches, industries, and geographies. But even the strongest individual firms are comparatively fragile. They can be sunk by voracious competitors, bad management, unpredictable shifts in technology, political meddling, a failure to keep up with trends, corruption and scandal. Moreover, any firm’s stock can endure a bad run that can be difficult to stomach. Tesla, for example, has lost more than 50% of its value since its share price peaked in November 2021. Many investors just can’t handle that level of decline, sell up, and crystallise their loss.

Equity ETFs

ETFs are the antidote to the company risk inherent in individual stocks. Equity ETFs are a type of investment fund that owns the stocks of hundreds or even thousands of firms. When you purchase ETF shares, you gain exposure to the ETF’s portfolio of stocks instead of laboriously building your own. In a single move, an ETF spreads your risk across entire industries, stock markets, regions, and even the world. By investing in a diversified ETF, you do not have to worry about predicting the future or identifying individual winners and losers. Instead, you are relying on the productivity of a healthy ecosystem of stocks to produce good long-term returns that can power you towards your investment goals.