|Equities - Stocks
For centuries, entrepreneurs have prospered and become wealthy through the direct ownership of various forms of business enterprises. In more recent times, stock markets have developed to facilitate the buying and selling of portions of businesses to people not involved in the daily operation of the company. Exchanges have made it easier for entrepreneurs to raise funds for a business through the sale of stock in their company. Today investing in stocks has become one of the most traditional paths to building personal wealth.
A share of stock represents ownership - equity - in a company. The owner is entitled to share in the profits, or losses, of the business. An investor’s motivation for investing in a company is for the potential benefit derived from the growth and profitability of the company over the long-term. New companies offer greater potential for growth and appreciation in the value of their stock. Established companies offer predictability of the business, price stability of the stock, and a steady dividend payment from the profits, once the need for new expansion capital has passed.
There are several classes of stock which a corporation may issue. The common shares represent ownership and participate in the selection of a board of directors who are responsible for hiring corporate officers to run the business. These shares are the most desired by investors since they will have greater potential for price appreciation as the business prospers. These shares also have the greater chance for loss if the corporation fails.
Classes of stock in a corporation -
- Common - represents ownership and claims on profit of the business; votes in the election of directors of the company.
- Preferred - preference is given on claim to dividends before common shareholders; non-voting shares; usually purchased for the higher but steady dividend.
Benefits of stock ownership -
- Long-term growth of the investment.
- Investing to keep ahead of inflation.
- Potential dividend income from profits.
Market Capitalization -
As corporations grow and prosper, the value of the company also increases. This is measured by the value placed on the stock of the corporation, known as the capitalization of the company. This capitalization is computed by multiplying the value of one share of the company’s stock by the number of shares outstanding - held by the public. As a corporation grows, it can move from a micro or small-cap stock to mid-cap and over time it may become a large-cap stock. The potential for price appreciation and volatility is greater with newer, small-cap stocks, and moderates as the company matures and moves toward large-cap status.
- Large-Cap - market capitalization greater than $10 billion; predictable dividend; usually a more stable stock price.
- Mid-Cap - market capitalization between $2 billion and $10 billion; company is growing; small dividend is possible; capital is used for expansion.
- Small-Cap - market capitalization less than $2 billion; growth may be rapid; usually no dividend; capital is need for growth.
- Micro-Cap - market capitalization is less than $300 million; rapid growth; capital need for growth and infrastructure.
Purchasing equities -
Investors may participate in the ownership of publicly traded companies by purchasing shares in a public market on a stock exchange, such as New York Stock Exchange (NYSE) or NASDAQ.
Diversification, a very important concept for investors, is achieved through owning many different companies, industries, and countries. Small investors should use mutual funds or Exchange Traded Funds for diversification when making equity investments.
Also, see Chapter 7 in the book Investing for Retirement - Surviving a Financial Tsunami.