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LeoGlossary: Stocks

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Also known as equity.

A security that represents fractional ownership in a corporation. Stock ownership gives one a right to the assets and profits of the company. This is dependent upon how many shares one owns.

One who owns stock is called a shareholder.

Stocks are traded on exchanges, which bring buyers and sellers together. The typical ones are the New York Stock Exchange (NYSE) or NASDAQ.

Businesses can use stock as a way to raise money. This is called "accessing the capital markets" (as opposed to the debt market).

There are generally two types:

  • Common
  • Preferred - often do not have voting rights yet have a higher claim to assets

Historically, stocks as an investment have outperformed other assets over the long run. The exception being Bitcoin which has a much shorter track record.

Publicly traded companies are regulated. In the United States, this falls under the supervision of the Securities and Exchange Commission (SEC). That is the agency responsible for ensuring companies adhere to the securities laws. When they go outside, the SEC will sue, bring civil litigation. If there is evidence of criminal activity, the Department of Justice will bring brought in.

Wealth Builder

Stocks are one of the primary vehicles that people use for building wealth. Over time, appreciation can result in massive financial gains. This is not, however, without risk. People can also suffer massive losses.

There are many examples where stock market bubbles were followed by collapses. The dotcom bubble was an example. In this situation, the NASDAQ crashed and took almost 15 years to recapture the pervious highs. The Crash of 1929 which kicked off the Great Depression is another example of a bubble bursting.

Those who invest in stocks long term tend to follow a similar path as Warren Buffett. Many consider him to be the greatest investor of all time. Buffett's basic approach is to find companies that he "never wants to sell". Through the use of good business practices, the company revenues and, in turn, profits keep increasing.

Buffett likes to look at his stock holdings as portions in a business.

Wealth is also generated by compounding, especially if dividends are paid. Many companies have payouts from the profitability equal to 2%-4% of the stock price. This can provide investors with a stream of income which can be reinvested in the company.

Stock Market

Stock markets around the world has an estimate market capitalization of over $95 trillion. The US markets had a market cap of over $46 trillion as of 2023 accounting for almost half of the total worldwide.

There are 60 exchanges around the world, with 16 that have a market cap totally over $1 trillion.

History

Stocks can trace their origins back to the Roman Republic. The state would lease out its services to private companies. These are similar to modern day corporations.

Cicero is known to have wrote about fluctuations in prices meaning there was market activity in these early days.

The trading of goods dates back to the earliest civilizations. Early entities would combine their financial resources to take ships to other countries. These transactions were either implemented by trading groups or individuals.

Throughout the Middle Ages, merchants assembled in the middle of a town to trade goods from different nations. This required a money exchange to ensure fair trade.

Antwerp, or Belgium today, became the center for international trade by the end of the 1400s. This is where buyers would engage in speculation on goods, in hopes of price increases.

The earliest recognized joint-stock company in modern times was the British East India Company. It was granted an English Royal Charter by Elizabeth I in December 1600, with the intention of favoring trade privileges in India. The Royal Charter effectively gave the newly created Honorable East India Company (HEIC) a 15-year monopoly on all trade in the East Indies.

In 1602, the Dutch East India Company issued the first shares that were made tradeable on the Amsterdam Stock Exchange. This is the entity that most associate with early stock.

Sectors

Companies are often categorized into sectors. This is a grouping of stocks which allows for comparison and analysis between firms that are similar.

They tend to be classified as such:

  • Consumer discretionary
  • Consumer Staples
  • Energy
  • Financials
  • Healthcare
  • Industrials
  • Information Technology
  • Materials
  • Telecommunications
  • Utilities

Stocks within a particular sector tend to affect the others, especially the one with the largest market share.

Market Cap

Stocks are also categorized based upon the market capitalization they have. This is basically a way to measure company size.

Market cap is determined by taking the company's outstanding shares and multiplying it by the present share price.

These are broken down as such:

  • Mega-cap: market value of $200 billion or more
  • Large-cap: market value between $10 billion and $200 billion
  • Mid-cap: market value between $2 billion and $10 billion
  • Small-cap: market value between $250 million and $2 billion
  • Micro-cap: market value of less than $250 million

This can be used by different index or investment funds to group companies together.

Market cap is a rough gauge of company stability. Larger cap stocks tend to be less volatile based upon market movements. The smaller the capitalization, the more it is susceptible to it.

Investors will often use market capitalization as a way of diversifying a portfolio. This could include a mixture of stocks for each category, as a way to reduce risk. It is done in light of the expected return that one is expected to generate.

Growth versus Value

There are two main types of stocks investors focus upon.

Growth stocks are companies that are expanding. These can be start ups which are disrupting an industry or one based around a new technology. All money is driven back into the business, seeking to enhance profitability and grow revenues.

Value stocks are established firms that are no longer in their high growth phase. These are steady, typically generating consistent revenues. Cash flow is now all put into operations. Instead, the Board of Directors will often approve dividends.

Many invest in value stocks in an effort to generate yield. With dividends, investors can determine the APR they are receiving.

Trading

Shares of a company can be transferred between shareholders. This is typically done through exchanges that list the stock. These bring buyers and sellers together.

Investors and traders access exchange through brokerage firms. An individual opens an account and funds it with a certain amount of money. From there, the ability to trade is offered.

Most jurisdictions have laws regarding the trading of public companies. This also applies to other assets traded on the exchanges such as commodities, bonds, and derivatives. Companies get on the exchange by meeting certain listing requirements.

Foreign companies will list on US exchanges in addition to the one in their home country. This is done in an effort to expose themselves to more capital. It is done by keeping a block of shares in a bank, usually as a percentage of the capital. The holding bank establishes American depositary shares and issues an American depositary receipt (ADR) for each share a trader acquires.

US corporations do a similar thing with foreign exchanges.

The Market

This is a term that people use to describe the U.S stock market, specifically the Dow Jones Industrial Average (DJIA). It is also known as "The Big Board".

It is an index of 30 prominent companies that are listed on different US exchanges. This is one of the oldest along with best known equity indexes.

Many feel it is not representative of the overall market as compared to other exchanges. The esteem for the DJIA dates back to the time when industrials were a larger part of the economy.

Wall Street

This is a section of New York City that is known as the financial center of the world. Some of the largest financial institutions were headquartered or had significant operations in this area. It is also home to the New York Stock Exchange (NYSE). Investment banks have a major presence, employing large numbers of people.

Wall Street also is associated by many with the stock market. This conjures up images not only of wealth but also greed, insider trading, and corruption.

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