Stocks

A stock (also known as equity) is a security that represents the ownership of a fraction of a company. This entitles the owner of the stock to a percentage of the corporation's assets and profits equal to how much stock they own. 

Units of stock are called shares, which are bought and sold primarily on stock exchanges.

Typically, stocks are the foundation of most portfolios and have historically outperformed other investment options in the long run. 

There are many ways you can participate in the stock market, but you can break down into two fundamental approaches: buy and hold long-term or short-term speculation.

There are several types of stocks, so lets breakdown the different types of shares from a company perspective.

• Preferred Stock - Preferred stock usually does not give shareholders voting rights. Preferred shareholders have priority over a company's income, meaning they are paid dividends before common shareholders. The dividend yield also varies from that of common stock, in that preferred stock dividends are calculated as the dollar amount of a dividend divided by the price of the stock. This is often based on the par value before a preferred stock is offered. It is commonly calculated as a percentage of the current market price after it begins trading, which is different from common stock that has variable dividends that are declared by the board of directors and are never guaranteed.

• Common Stock - Common stock usually gives shareholders voting rights, usually one vote per share owned. Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders.

When most people think of buying stocks in the stock market, what they are imagining is common stock.

You will also hear people refer to stocks by their characteristics:

• Growth Stocks - Growth stocks are those companies expected to grow sales and earnings at a faster rate than the market average. Growth stocks often look expensive, trading at a high Price-to-earnings (P/E) ratios. On the risk spectrum growth stocks would fall into the high-risk category. Since investors are paying a high price for a growth stock, based on expectation, if those expectations aren't realized growth stocks can see dramatic declines. Also, growth stocks typically do not pay dividends, so there is not that safety net of income from cash flow, it is all relying on capital appreciation.

• Dividend Stocks - Dividend stocks are companies that pay out regular dividends. Dividend stocks are usually well-established companies with a track record of distributing earnings back to shareholders. On the risk spectrum dividend stocks would fall into the low-risk category. We are not talking about high-yield dividend trap companies who are trying to entice investors to buy their stock with high-yields, when in reality the fundamentals of the company are rotten. We are referring to high-quality companies who are distributing reasonable dividends because of their established business models, they do not need to reinvest the profits for growth and can afford to share those profits with shareholders.

• Value - Value stocks are companies that tend to trade at a lower price relative to their fundamentals, such as dividends, earnings, and sales, making them appealing to investors with longer time horizons. The goal with value stocks is to buy these companies at bargain prices (low) and sell them down the road when they have reached their price potential (high).

This is a long-term approach that is based on fundamental research of the past and present earnings of a company, their industry outlook, and competitive advantage. 

The goal is to find and invest in quality businesses that are going to provide a return or dividend for the long haul. Therefore the buy and hold investor is less concerned about day-to-day price movements. 

 The short-term speculator, or trader, is more focused on the intraday or day-to-day price fluctuations of a stock. They often take a more technical approach, looking at charts and statistics that may provide some insight on the direction the stock may be heading. 

The goal is to buy low and sell high for quick profits. They may also participate in "shorting" a stock, which allows them to sell a stock they don't actually own. 

This strategy is used when a trader thinks a stock will decline in price, allowing them to profit from a downward movement. However, shorting a position can lead to theoretical unlimited risk if the security rises in market value, as there is no ceiling to how far a stock's price can increase.

These two general approaches are a basic sample of how stocks can be used as either a long-term investment, or a short-term speculative tool. 

How you decide to invest and trade in stock should depend squarely on your goals and risk tolerance.