Tips For Those New To The Stock Market Game!
Here’s a message to readers who have never owned a share in a company, or to those who haven’t yet followed stock tickers on the news: don’t be intimidated by the stock market game. From investors saving for retirement, to employees working in a publicly traded company, almost everyone has a hand in millions of transactions that occur daily in the financial markets. Here are a few key facts about the world of finance and the lowdown on how greenhorns can get started.
What is a stock? A stock represents ownership in a company. Upon purchasing a stock, an investor becomes a shareholder in that particular company, and is able to benefit from its earnings growth and dividend payouts, while having voting rights. Not all companies are traded on the open markets – those that aren’t are termed to be ‘private’. For investors that do hold stock in a publicly traded company, their primary goal is to achieve a positive return in the future. As mentioned above, a stock can generate a return on investment in two ways: earnings growth and dividend payouts. Additionally, stocks can either be ‘common’ or ‘preferred,’ with the latter receiving first dibs on dividends and bankruptcy payouts, if such an event were to occur. Looking at it from the other side of the aisle, stock issuances allow a company to raise funds for any business-related activities. While this is a distinct advantage over their private peers, publicly traded companies are also subject to increased government regulation, in the form of increased financial disclosure.
Where are stocks traded? At the beginning of a stock’s life, it is sold to investors in what is known as an initial public offering (IPO) through a process known as underwriting. Upon being issued in the primary market – as it is known – a stock can be bought or sold on the secondary market. Also known as the ‘aftermarket’, stocks here are traded on exchanges. The typical exchange can either be classified as a physical market or an over-the-counter (OTC) market. In the former, stocks are bought and sold on a traditional market floor, while an OTC market replaces this with an electronic network. The world’s largest physical market – in terms of market capitalization – is the New York Stock Exchange, while the largest OTC market is the NASDAQ.
Are companies grouped together in any way? Typically catalogued by their ticker – for example Apple’s ticker is AAPL and Google’s ticker is GOOG – there are a few ways that investors can group stocks. First, they can be arranged into sectors based on the nature of a company’s business. For example, Exxon Mobil (XOM) produces gas and oil, so it is classified under the ‘Basic Materials’ sector. Within each sector, there are a variety of industries – in XOM’s case the stock is in the ‘Major Integrated Oil & Gas’ industry. Another way to organize stocks can be done by comparing the relative sizes of companies, in terms of market capitalization. Briefly mentioned above, a company’s market capitalization is the full value of its tradable shares. The largest companies are termed ‘mega-cap’ and are over $200 billion. Some examples of these titans are the aforementioned Apple, Google, and Exxon. Below this designation are companies known as ‘large-cap’ over $10 billion, ‘mid-cap’ companies between $2B and $10B, ‘small-cap’ companies between $250 million and $2B, ‘micro-cap’ companies between $50M and $250M, and ‘nano-cap’ companies below $50M. Typically, companies with smaller market values are less liquid, meaning they are harder to trade have more expensive brokerage fees.
Do some stocks perform better in a recession? Defensive stocks perform better in a recession, while cyclical stocks do not. Regarding defensive stocks, these companies sell products or services that can be sold no matter the economic environment. Some examples of classic defensive stocks are industries like food and utilities. Cyclical stocks, on the other hand, are more sensitive to changes in the economy and give investors satisfactory returns in expansion years, while typically providing negative returns during recession-era years. Cyclical stocks are in industries like automobile, clothing, and restaurants, where consumer demand typically falls during hard economic times.
Do investors have different preferences when picking stocks? In the stock market game, there is a choice for every type of investor. For the bargain-bin investors, there are stocks known as value stocks. A value stock is undervalued with regard to its underlying fundamental characteristics. Investors determine if a stock is undervalued by using metrics like Price-to-Earnings and Price-to-Book. Over the last 100 years, stocks have returned roughly 9 percent per year, when looking at the Dow Jones Industrial Average. In most cases, about half of this return is from capital gains yield while the other half is from dividend yield. Within this timeframe, obviously, there have been ups and downs. The years with positive returns are termed ‘bull markets’ and the years with little to negative returns are termed ‘bear markets’. In most cases, the latter occurred during the events like the Great Depression and the more recent Great Recession.
How are stocks analyzed? Finally, there are two primary methods that investors use to analyze stocks. The first, known as the ‘fundamental method’ consists of financial statement analysis, specifically looking a company’s balance sheet, cash flow statement, or income statement. Ratios and growth rates can be derived from this method, which is what most of the articles on WealthLift use. The other main school of though is known as the ‘technical method’ where investors actually analyze a stock price’s charted behavior over time. For this form of analysis, numbers are
irrelevant, as technical analysts only pay attention to stock price patterns. Interestingly, the majority of universities teach solely fundamental analysis, thus most people in the financial industry use it. Technical analysis is kind of like the ‘wild-west’ in terms of stock analysis – it is newer and viewed as illegitimate by many mainstream investors.
In terms of the stock market game, the possibilities facing a new investor are endless. From the facts presented in this article, to the tools available on WealthLift.com, it is up to the individual to take control of his or her financial future by gaining a sound knowledge of the world of finance.
Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours. He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.