Many people find that investing in the stock market little better than gambling in a casino. Others think of the image of men leaping to their deaths in the Great Depression and think that stocks are some form of addiction that could kill. Granted there are risks in investing in the stock market but you shouldn't view it as a rarefied sanctum that only few can achieve success. Before you can decide if you want to invest in stocks, you should first understand what stocks are all about.
To put it simply a stock is your stake in a company. It is more than a piece of paper, it is proof of your investment in a company. When you own shares of stock you become part owner of the company. You are now involved in how well the company does. If the company does well, your stock will increase, conversely if the company loses money you'll likely end up broke. Ownership of stock is represented by a stock certificate. A stock certificate represents your ownership of the company. These days, when you buy stock of a company, you usually do not get the actual stock certificates any more. Instead, your ownership is tracked electronically, making it easier to buy and sell shares.
Why do companies issue stock? And why do investors pay such huge sums of money for little slips of paper? Companies go public in order to raise capital. Stock raises capital without creating debt and without creating a legal obligation to pay off those debts. In return the buyers of stock expect their investment to give them more money. It really is as simple as that. They expect other people to pay more for their investment than they paid for.
Dividends are certainly more tangible income than potential earnings increases and stock price increases, so what does it mean when a dividend is non-existent or very low?
And what do people mean when they talk about a stock's yield?
To begin with the easy question first, the yield is the annual dividend divided by the stock price. For example, if a company is paying 1 per year and is trading at 10 per share, the yield is 10%.
A company paying no or low dividends (zero or low yield) is really saying to its investors -- its owners, "We believe we can earn more, and return more value to shareholders by retaining the earnings, by putting that money to work, than by paying it out and not having it to invest in new plant or goods or salaries."
And having said that, they are expected to earn a good return on not only their previous equity, but on the increased equity represented by retained earnings.
So a company whose book value last year was 10 and who retains its entire 1.50 earnings, increases its book value to 11.50 less certain expenses.
That increased book value - let's say it is now 11 -- means the company must earn at least 1.65 this year just to keep up with its 15% return on equity.
If the company earns 1.80, the owners have indeed made a good investment, and other investors, seeking to get in on a good thing, bid up the price. That's the theory anyway.
In spite of that, many investors still buy or sell based on what some commentator says or on an announcement of a new product or on the hiring (or resignation) of a key officer, or on general sexiness of the company's products.
The bottom line is this in stocks: research first, buy low and sell high and you'll never go bankrupt. Of course it's a lot more complicated than that but we're talking about the basics and you can't go wrong with that.