Investing in common stock- Excerpts of the book "Finance for dad"

What is a common stock?

It is defined as a security that represents ownership in a corporation. When investing in stocks of a corporation, you become a co-owner. Through the stock market, you can become a co-owner of Apple, IBM, GM, DuPont, Microsoft or any other iconic company. Owning stock in a corporation gives you the right to attend meetings and vote for decisions to be taken. It also gives you the right to choose and to be chosen to be part of the administration. However, since these corporations release a high number of shares, you need a substantial investment to be part of the decision-making process. Stocks do not have a specific expiration date, they are everlasting. You can keep them for as long as you wish.

What are the risks of investing in stocks?

There are many risks. In the first place, the commercial one; meaning that you can lose all your money. When you buy stocks, you accept that risk. If the company fails, goes bankrupt, the owners (those who have shares of the company) are paid out last after creditors are paid. Bondholders are paid ahead of the stockholders when it comes to getting investment funds back from a failed company. The second aspect you should keep in mind is prices fluctuation. Sometimes stock prices (even the best companies) can drop dramatically and it may take a long time to recover. Investors must be prepared for market fluctuations. But the most… most important risk, also related to market fluctuation, is inexperience. If you buy stock without having enough knowledge of this area or previous psychological preparation, you can lose money because you won’t be able to handle the pressure of seeing stock prices drop temporally. If you don’t know what’s going on, you will feel scared and you will sell at the worst time. The chances are that in a few weeks or months you will see that those prices got back on track, but you will have already sold them.

How can you make money by investing in stocks?

As you invest in stock, it is possible to make money in two ways: through dividends that corporations release periodically among its shareholders and through price appreciation, that is, capital gain. Both kinds of earnings are variable. Shareholders are not guaranteed that they will receive return on their investment from the executive board of the company. Although most companies offer the possibility to get benefits both from dividends and capital gains, it is possible that some companies don’t. So, it is important, when investing, to know what kind of company you are getting involved with. If it is a new company, the board of directors probably will use all the profit to leverage growing projects. Therefore, shareholders will not see dividends for a long time. On the other hand, mature companies use part of their profits to continue growing and they share the rest with their shareholders. Capital gains are produced as a result of the fluctuation of prices on the stock in the market. It is the difference between a higher selling price and a lower purchase price.