The Investing Minister

Helping ministers and seminarians learn to invest successfully

What Are Stocks?

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Over the course of the blog thus far, I’ve covered pretty much all of the preliminary information I wanted to cover before getting into investing itself. The purpose behind doing so was simple:

Assuming you, the reader, were starting from square one with little (if anything) already invested and with little investing knowledge, I needed to walk you through some initial information to ensure that you understood:

I hope that what I tried to do with that progression is clear. Some of you may have been disappointed, since you came to the blog expecting me to talk about the ins and outs of investing from the very first post.

But I intentionally refrained from doing so because, honestly, that’s not what many of you readers needed at first. Instead, you needed a walkthrough of sorts regarding all the advance preparation to ensure you are where you need to be before we start talking about investing proper.

You need a solid foundation of personal finance before you really focus on investing. Are you there? If so, then let’s move forward.

The purpose of this post is to provide you with a brief, general overview of stocks as an asset class. Stocks are going to make up a significant portion of your overall portfolio in order for it to achieve the growth you’ll need for meeting your long-term financial goals.

Notice I said “long-term” there. That’s important, and we’ll get into that more in a later post. But for now, go ahead and correlate stocks with time in this manner:

Stocks are a long-term investment. Drill that into your mind and keep it there.

What Is a Stock?

So what is a stock? At its most basic level, a stock is a security that gives the stockholder a share of ownership in a company. The units of stock a company issues are referred to as “shares.”

The more shares of a company one owns, the greater percentage of ownership of a company one has, though keep in mind that any individual typically owns only a very small percentage of a company’s outstanding shares. If you own the stock of a company, you are referred to as a “shareholder” of that company.

Each publicly traded company has its own arrangement of characters, known as a “ticker symbol,” that can be used to follow the price of one share of its stock at any given time, both during and after trading hours on the major stock exchanges.

Following the price is as simple as Googling the ticker symbol or entering it into a stocks app on your smartphone. For example, Apple’s ticker is AAPL. Microsoft’s is MSFT. If you don’t know the company’s ticker, you can Google it to find out.

So what does it mean to “own” a company through the shares one holds? Why would a company issue shares in the first place, and what benefit is there to owning the shares?

First of all, a company that desires to “go public” issues shares and sells them to shareholders in order to raise capital, i.e. to fund the company’s operations. (Companies can also do this through issuing bonds, but that’s for a later post).

Not all companies are publicly traded. For example, Chick-Fil-A is a privately-held company, the ownership of which is not made available to the public. Wal-Mart, though predominantly owned by the well-known Walton family, is a publicly traded company.

If you wanted to go out and buy a share of Wal-Mart today (Wednesday, October 7, 2020), you could before the market closes at 4:00 PM Eastern. If you wanted to go out and buy a share of Chick-Fil-A today, you could not, because it is privately held.

I’ll simplify here, but at what is known as an “initial public offering” (IPO), a company going public has determined a set number of shares to issue, and these shares have been set at a specific price for their initial offering.

The shares enter the public market on the date of the IPO, where they are immediately traded (bought and sold) on a stock exchange, with the market (all buyers and sellers considered collectively) then determining future price movements based on demand for the stock (how much investors are willing to pay per share).

The benefit to owning shares of a publicly-traded company is in the expected future financial gain that comes from owning the shares. This gain can come in two ways:

  1. Dividends declared by the company — Dividends are distributions of a portion of the company’s earnings to shareholders. The company examines its earnings (typically quarterly) and determines what amount of those earnings should remain with the company to continue funding operations and what amount, if any, is available to be distributed to shareholders.

    For example, Microsoft’s most recent quarterly dividend declared was $0.56 per share. So, in this example, if on November 17, 2020, you own exactly 1,000 shares of Microsoft, you, as a shareholder, will be entitled to a dividend payment of $560. Microsoft, as a business, made money, so they, in turn, will be distributing some of that money to you, since you are a shareholder.

    It’s important to note that companies are not required to distribute dividends, even if they have distributed them previously. Some companies do not declare any dividends at all, in fact, instead choosing to direct all of the money that could have been distributed as dividends to efforts to grow the company further. And that then brings us to the second way one can gain financially from owning shares of a company.

  2. Appreciation of the share price of the stock — As I’m sure you’re aware, even if you do not have much previous investing experience (or any at all), the prices of stocks fluctuate every weekday during the stock market’s trading hours.

    Without getting into the technical details of everything that goes on with every market transaction, the summary of why this occurs is because the price that any given buyer is willing to pay for a share of a specific company’s stock is always changing, and is always in regard to how well (or how poorly) that buyer expects the company to perform in the future, whether short-term or long-term.

    Most individuals, naturally enough, desire for the price of the stock they purchased to increase over time, so that when they eventually sell their shares in the market, they sell them for more than they paid for them, thus earning a profit. So there is an expectation on the part of the buyer, in most instances where a buyer purchases a company’s stock, that the price of the stock will appreciate over time.

    For example, let’s say you bought $100.00 of Apple stock on January 4, 2010 and held it to January 6, 2020. Your initial $100.00 of Apple stock, with dividends automatically reinvested over that ten-year period, was worth $1,473.03 on January 6, 2020. The price of a single share of Apple stock appreciated over time, and the dividends from the stock were automatically reinvested to purchase additional shares, making your $100.00 now worth $1,473.03.

    Of course, that profit was only “on paper.” Why? Because you still owned the shares, which are shares of Apple, not cash. In this example, if you wanted to realize that profit by selling, you would have sold your shares on January 6, thus returning your initial $100.00 back to you along with $1,373.03 more, giving you $1,473.03 total in cash (note that for the more advanced among you, I simplified here by eliminating the bid-ask spread and assuming you got the closing price of the stock exactly, and by eliminating any commissions on the trade).

Am I Guaranteed to Profit from Owning a Particular Company’s Stock?

So if that’s all there is to it, why not just pour all of one’s money into a single company’s stock that one thinks will do really well and ride it into the stratosphere? Well, so far we’ve only talked about a stock’s price going up.

The reality is that the prices of individual stocks frequently go up and down by both large and small percentages, and for a variety of different reasons, each of which is beyond the purview of this post.

What you should pay attention to, then, in what I just said is that the price of a stock could very well go down rather than up. And it’s not just that it could down temporarily, but that it could go down for a very long time. In some instances, it could even go down and stay below the price you paid for it for longer than you ever intended to hold it in your portfolio.

Is it conceivable that you could buy an individual company’s stock today, that its price could drop precipitously tomorrow, and that the price could stay below what you paid for it all the way up until the day you die in your 80s? You’d better believe it is!

What this means in summary is that no, you are never guaranteed to profit through price appreciation from owning a particular company’s stock. Ten years from now, the share price of a company’s stock could be 25x the price you paid for your shares. Or ten years from now, the share price of that company’s stock could be pennies. There are no guarantees of stock performance.

If Stocks Are So Volatile, Why Invest in Them?

If stock prices move up and down so frequently, and if it is possible to lose money by investing in an individual stock (or even more than one), then why invest in stocks at all? Are they not too dangerous?

I’ll be dealing much more with stocks in future posts as we progress into the most prudent ways to invest, but for now, let me briefly answer the question of why one should invest in stocks as an asset class at all like this:

We invest in stocks as an asset class because they have historically been the most reliable way to generate a significant amount of return in an investment portfolio over the long term.

Going all the way back to the very first post of this blog, I told you that you must invest in order to meet your financial goals. Considering the amount of growth that is necessary in order to achieve those goals (most importantly, a financially secure retirement), something in your investment portfolio is going to have to provide most of that growth. And that’s exactly where stocks come in.

Are they risky? Yes. Are they necessary? I’d be misleading you if I told you that they weren’t. But don’t fear; we’ve got a lot more to cover ahead of us in future posts.

So that’s an overview of stocks in a brief, simplified post. There’s a lot of detail I left out, but if you have any comments or questions, fire away in the comments section of the post, and I’ll do my best to respond.