3 Things You Should Know About Stocks Before You Invest

Happy Thursday, all! Or, as I like to call it, ‘almost-friday.’ Earlier this week, we talked about what exactly an investment portfolio is. I hope everybody enjoyed that post, because today we’re going to go farther and discuss 3 things you should know about stocks before you invest!

When I tell someone that I’m invested in stocks, I usually see them cringe. Most people assume that investing in stocks is a complete gamble. This is only true if you invest by speculating rather than by analyzing. Essentially, you’re going to be gambling if you’re putting your money into something you don’t understand, every time. So to get you started, let’s outline the 3 most important concepts you need to understand before you delve into the world of stock investing.

What is a Stock?

First, it is important to understand exactly what a stock is and how they work. Stocks, also known as securities, are portions of a company that you can buy. Imagine it as if the business were a physical object sliced into portions. You are free to buy as many of these portions as you can afford, granted they are for sale on a public market.

Let’s use a real life example. Imagine that you opened a store selling stamps. Your store does really well and you’re making a good profit. You would love to expand your store and have multiple locations from which to sell your stamps. The cost to expand your store is substantial, so you need to figure out how to raise some money. One option is to go public with your company with an IPO. An IPO is an Initial Public Offering.This is where a company that is privately owned (by you) goes public (selling portions of the company to the public). It is then placed on a public stock exchange where anyone can purchase shares.

When a company is placed on a public stock exchange such as the TSX/TSE (Toronto Stock Exchange), Nasdaq, NYSE (New York Stock Exchange), etc., it becomes available for the average person to purchase shares through a brokerage account. We will cover brokerage accounts at a later date.

When a person purchases a share of your company, they become the owner of that share. They are then free to sell that share if they would like to at a later date, as long as someone will buy it from them.

Basically, if you needed to raise money to expand your stamp shop, you could split your business into parts. These are shares and you can sell off a portion of your business on a public exchange and use the money you gain to expand. Once people have bought shares of your company, they are free to trade them between each other on any stock exchange.

It is important to note here that many people forget that when they are selling a share, somebody else is buying that share . And the opposite is true as well (when you are buying, somebody else is selling.) Because of this, you have to think twice before making a trade. Why is somebody else selling, when you’re buying?

How Does a Stock Make Money?

The second thing you need to know is that there are two basic ways you can make money from a stock. The first way is if the stock’s price rises. In this case, the overall value of your investment will rise.

To find the price of a stock you can visit Google Finance. Just search up a company by name or ticker symbol to see if it is traded and view its current price for one share:

How to tell the price of a stock with Google Finance

You can see the Bank of Nova Scotia (BNS) here has a price of $62.93 per share at the time of this writing.

For the sake of simplicity, let’s pretend BNS is trading at $60 per share. If you have $120 you can buy 2 shares. If BNS goes from $60 per share to $75 per share, you have gained $15 in valuation per share. That equals out to $30, or a 25% return on your original investment!

Obviously the opposite is true as well, if BNS drops from $60 per share to $55 per share, you have lost $10 ($5 loss per share) which amounts to an 8% loss of the original value. It is important to remember that stock prices fluctuate daily and that, in reality, you don’t lose any money until you sell your shares at a price lower than what you paid. Similarly, you will not realize any gains in value unless you sell at a price higher than what you paid.

At this point, you may think that investing is all about timing the market. If you can get in at a low price and time the stock so that you sell out at the highest point, you win right? This is a lot easier said than done. In fact, it is better to just accept that timing the market is impossible. However, there are ways to earn consistent returns, which we will discuss later.

The second way you can make money on a stock is more direct. Many companies take their extra income and give it to shareholders, this is called a dividend. A dividend is a cash deposit made by a company into your investment account, usually quarterly (every 3 months.) A stock’s dividend yield is what you can expect to receive, in percent, of your investment back every year at the stock’s current price. Typically, a dividend yield is listed somewhere near the stock price.

In Google Finance, the dividend yield is found like so:

How to Tell the dividend and dividend yield of a stock with Google Finance

Here is an example of the Bank of Nova Scotia (BNS).  They currently provide a 72 cent per share dividend yield. 72 cents is approximately 4.58% per year on your investment at this price. This means that an investor will receive 72 cents per share every year if BNS maintains their dividend payment. Quarterly, that’s 18 cents per share.

Again, pretend that BNS is trading at $60 but let’s maintain that 4.58% dividend yield. If you buy 50 shares of BNS for $3,000 (we will ignore commission fees for now) then you will receive $137.40 in cash per year at that price! Remember: you will receive the dividend yield based on how much money you have invested at the time of dividend distribution.

Typically, companies will maintain or increase their dividend over time. If they didn’t, people will not want to purchase shares of that company. Because companies typically maintain their yield, many investors exclusively buy stocks that pay high dividends in order to get ‘guaranteed’ returns.

A Stock is Not a Ticker Symbol

The third thing you need to know about stocks is that you are not investing in a ticker symbol. The ticker symbol is the lettered abbreviation making up a stock’s name. For example, Apple is AAPL, Canadian Tire is CTC, and the Bank of Nova Scotia, our previous example, is BNS. Rather than these symbols, you’re investing in the business behind them.

If you turn on the news you will see stock tickers flashing by the bottom of the screen. They have green or red numbers indicating how much that stock has lost or gained in that day. It is important to ignore this day-to-day fluctuation in stock prices. For a real, long-term investor, the focus is on the investment’s return over years, not days.

Warren Buffett, one of the greatest investors of all time, says that if you would not buy a company outright, you should not buy a single share. Likewise, owning a single share is like owning the entire company. This is a key concept that many people who invest do not understand. When you are investing, you are buying a portion of that company. Therefore, it is important that you take the time to analyze a company. You don’t want to own shares of a sinking ship.

If you feel that I have missed something important or if you have anymore questions, leave a comment below. I will get back to you! If you are interested in hearing more and want to get the Simplifying Finance “eye-level” cheat sheet to help you value stocks at a glance, sign up for our insiders list!

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One Response to “3 Things You Should Know About Stocks Before You Invest

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