We have all probably heard of stocks and may know someone who monitors the stock market regularly. But what exactly are stocks and what can you expect to get by investing in them?
Well, stocks represent ownership of a company; a claim on the company’s assets and earnings. Owning stocks means that you are an owner of a business, one of many owners. As you acquire more stock (by investing more money), your ownership stake in the company becomes greater. Shares, equity, or stock all mean the same thing.
Now, you may be wondering- can I become the owner of any business or company? Perhaps, you have seen a popular restaurant that definitely makes good money and want to invest in that. However, you may or may not be able to do so. It depends whether the business you want to invest in is listed on the stock exchange. In Singapore, the stock exchange is the Singapore stock exchange or SGX for short. A stock exchange is like a market where investors and traders can buy and/or sell stocks. Of course, all this business is now electronically online. Thus, companies listed on a stock exchange also known as public companies are those that we can trade freely over the stock exchange during trading hours.
Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, you get voting rights per share you own to elect the board of directors at annual meetings and that is generally the extent to which you have a say in the company. The management of the company is supposed to increase the value of the firm for shareholders (by undertaking profitable projects, coming up with new products and services,etc). If management does not do a satisfactory job, shareholders can vote to have the management removed, at least in theory. In reality, individual investors like you and I usually don’t own enough shares to have a significant influence on the company. However, making such decisions is also probably best left to the institutional investors and billionaire investors who are more experienced and business savvy.
We are more interested in the moolah! Shareholders like you and me are entitled to a portion of the company’s profits. Profits are sometimes paid out in the form of dividends. We would be more interested in this as well as the value of our shares. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends. For example, Apple despite making money for years since their turnaround in 1997 only started giving dividends to shareholders from 2012 onwards. However, as the company was able to come up with innovative products and add value, more investors started buying up Apple shares which drove the share price up. If one purchased $1,000 worth of Apple shares in June of 1997, when shares were trading as low as $3.56 a share, that investment would be worth over $600,000 in 2012!
Capital appreciation is a rise in the value of an asset based on a rise in market price. If one buy the stocks at a low price and later on sells them for a higher price, this is an example of profiteering from the changes in market value of the stocks. In general, a consistently profitable company tends to see its share prices appreciating while a loss making company tends to have falling share prices. Market prices are determined based on supply and demand. For a loss making company it is understandable that existing investors will try to get rid of the shares as there may be better investments while new investors will be more likely to invest in other profitable companies instead. As such, given the high supply (existing investor selling) and low demand (little or no new investors buying) for the shares of loss making companies, the shares of loss making companies tend to depreciate while the converse is true for growing and profitable companies.
Thus, there are generally 2 ways to make money from stocks- dividends and capital appreciation/growth. Hence, many investors try to pick stocks that either pay out high dividends or have the potential for capital appreciation. There is a fortune to be made from picking the right stocks! Since it was listed on the NASDAQ stock exchange in December 1980 to now, apple shares have yielded an immense 31,590.90% cumulative returns. When Amazon listed its shares on May 1997, it hit the markets at $18.00 per share and now, it is up 20,000% soaring to a record high of over $721 a share. For every success story like Apple or Amazon, there are numerous flops; companies that went out of business leaving their investors with empty pockets.
Hence, it is wise to proceed with caution when investing in equities. Do your due diligence- read up about the company, make sure you understand what business the company is in and analyse their financial performance. It is never wise to invest in a company which has been making losses for many years. However, it is understandable that some companies in high growth industries may have tremendous growth potential but may currently be making losses due to expenses incurred in gaining market share. In such circumstances make sure you understand their business, see if their business model makes sense and that they are able to manage their cash flows well.