Stocks, company shares, equities. These investments go by a few different names and are a fundamental part of many investors' plan to build wealth. But that doesn't mean they're easily understood. To help get you up to speed, we're here to share (get it?) some knowledge about stocks and how different types could be useful to you as an investor.
What are stocks?
Stocks represent partial ownership of a company. Depending on the stock type, they may also grant shareholders the right to vote on certain decisions affecting the company.
How do stocks work?
In a nutshell: Stocks can help companies and investors make money. For companies, money comes from the payments they receive when investors first buy their shares. This cash infusion can help companies in a variety of ways, such as helping to pay off existing debt and funding growth plans they can't—or don't want to—finance with new loans.
Investors, meanwhile, can make money from stocks in 2 ways:
- Share appreciation. When a company does well financially or becomes more desirable, the value of its stock can increase. This allows investors to sell their shares to other investors for more than they paid.
- Dividends. Certain companies may decide to share a portion of their financial success with investors through cash payments called dividends. These are normally expressed as a percentage of a share's value, often 1% to 3%, and are not guaranteed. Companies may pay them one quarter and skip the next, depending on their goals and financial situation.
Keep in mind that stock values don't always go up. Share prices can also fall, leaving investors with stocks worth (sometimes a lot) less than they paid for them. You can help decrease this risk by diversifying your investments and through a strategy called dollar-cost averaging, where you regularly invest a specific sum of money over time. When prices are low, you can afford to buy more shares. When they're high, you'll buy fewer.
But keep in mind that dollar cost averaging does not assure a profit or protect against loss in declining markets. For the strategy to be effective, you must continue to purchase shares in both market ups and downs.
Types of stock
Public stock is probably what you have in mind when you think about stocks. It's the kind of stock you can easily buy through brokerages and investment apps, and its price movements could be covered in the news.
A stock is "public" when its company lists it on major exchanges, like the New York Stock Exchange (NYSE) or Nasdaq. This enables everyday investors to buy and sell it, but it also opens companies up to more regulation. If companies are accessible to everyday investors, the Securities and Exchange Commission (SEC) requires that they disclose certain aspects of their finances to help investors make informed decisions.
Private companies can go public through processes like initial public offerings (IPOs), direct listings, or special purpose acquisition companies (SPACs).
Private stock represents ownership in a private company. Unlike public stock, private stock can't easily be bought or sold through a normal brokerage account. Usually, any sale of private stock needs to be approved by the company itself.
Private stock is rare for the typical investor to encounter, which can be a good thing. Private companies are much less regulated than public ones and have no obligation to inform the public of their financial health, making it harder for outsiders to judge investment potential. If you work for a private company, however, you may receive private stock as part of your benefits or compensation package.
Common stock is the "average joe" of equity. It's the public and private stock type you're most likely to buy and sell.
Common stock represents ownership of a company and gives the shareholder voting rights, letting them influence that company's future. It primarily derives its value from price appreciation, though it may also provide dividends.
Common stockholders are the last people—behind bond holders, preferred stockholders, and other debt holders—to be compensated if a company goes bankrupt and must sell its holdings.
Preferred stocks are like a mix between a common stock and a bond. They typically provide regular income through higher-than-average dividend payments, like a bond might with interest payments. Their shares also grant you ownership of a company like common stocks and may appreciate in value as the company becomes more desirable. And "convertible preferred stock" may be converted to common shares by the company or by you if certain conditions are met.
Unlike common stocks, preferred stocks don't come with shareholder voting rights. Another difference: They have preferred status to receive payment when a company goes bankrupt and sells its holdings to pay off its debts and compensate its owners.
Growth stocks are shares of companies that investors expect to grow quickly and rapidly increase their price. Usually, growth stocks belong to smaller, newer companies that have a lot of potential but (at least in the moment) not a lot of profit. Growth stocks typically don't pay dividends, as the companies may prefer to invest extra cash in themselves to grow faster.
Growth stocks tend to have stock prices that are much higher than you might expect compared to their actual earnings. When you buy one, you're hoping that company's performance eventually catches up to the expectations of its share price. There's no guarantee that a growth company will get there. And if it doesn't, investor favor may fade, sending prices down. This makes them riskier investments.
Value stocks are associated with companies that investors think trade below what they're really worth, based on their earnings. They tend to be larger, more established companies with solid financial histories. Some even pay dividends.
If you own a value stock, you're hoping the market eventually realizes the stock is undervalued, and its price bounces up. If it doesn't, you may be left holding a stock with good financial fundamentals but that never realizes its potential.
Unlike growth or value stocks, income stocks focus on generating profit primarily from dividend payments. Growing their share price is an added bonus.
Income investing can be risky because companies can reduce their dividend or choose not to pay one at any time. To help decrease that risk, income investors focus on companies' dividend history, making sure they've consistently paid or raised their dividend even in down markets.
How to buy stocks
These days, buying stocks is as simple as opening a brokerage (or regular investment) account online. Picking a broker is an important decision that you shouldn't take lightly. You want a firm that won't hold you back with fees, hidden costs, or a lack of investment availability. For more information, check out our guide on where to open a trading account.
Once you have an account, your next move is to select the stocks you want to buy. Check out these 4 steps to picking your investments. And remember: You don't have to stick with buying individual shares. Mutual funds and exchange-traded funds (ETFs) can provide easy access to hundreds of different stocks at once, providing broad market exposure.