What are stocks and how do they work?

 

When people think of investing, the first thing that comes to mind is stocks. Stocks and bonds form the basis of a balanced investment portfolio. Owning stocks of a company means you share in its profits and growth. In this article, we will understand what stocks are, what are their types, and how you can participate in this exciting market.

 

What are stocks?

Stocks, also known as equities, represent partial ownership in a company. When you buy stocks, you are actually buying a small part, or share, of that company. There are several potential benefits to being a shareholder:

• Capital Gains: If you buy a company’s stock and its price increases, you can sell it for a profit.

• Dividends: Some companies distribute part of their profits to shareholders, which can be in the form of cash or additional stock. In the UK, companies usually make these payments quarterly or every six months.

• Voting Rights: If you own shares in a company, you may also have the right to vote at the annual general meeting.

 

 

Main Types of Stock

There are two main types of stock: common stock and preferred stock.

Shareholders who hold common stock have the right to vote on company policies and to participate in the election of the board of directors. They may also receive dividends, but they are paid last if the company goes bankrupt. Most investors buy common stock.

Holders of preferred stock generally do not have voting rights, but they receive dividends first and have a priority claim on the company's assets if the company goes into financial trouble.

There are several subtypes of preferred stock:

• Callable shares: The company can buy back these shares at a specified price in the future.

• Convertible shares: These are preferred shares that can be converted into common shares after a specified period.

• Cumulative shares: If a dividend is not paid in a given period, the company must pay it to preferred shareholders at a later date.

• Participatory preferred shares: These are paid at a fixed rate, but additional dividends may also be paid if the company achieves certain financial goals.

 

Other common types of stocks

Stocks are also divided into different categories based on their nature and company size:

• Growth stocks: Stocks of companies whose earnings and profits are expected to grow faster than normal. They usually do not pay dividends.

• Income stocks: Companies that pay regular, high and stable dividends. Their prices are also less volatile.

• Value stocks: Companies whose stocks seem undervalued compared to their actual financial performance.

• Bluechip stocks: Stocks of large, stable and well-known companies, such as AstraZeneca (AZN).

• Large-cap stocks: Stocks of large companies with a market value of more than $10 billion (included in the FTSE 100 index in the UK).

• Mid-cap stocks: Stocks of medium-sized companies with a market value of between $2 and $10 billion (included in the FTSE 250 index).

• Small cap stocks: Stocks of small companies with a market value of between $300 million and $2 billion. They have a high potential for profit but also a high potential for risk.

• Penny stocks: Stocks that trade for less than one pound (£1). They have a high potential for risk but also a high potential for profit.

 

 

Major stock market sectors

There are over 30 different stock market sectors in the UK. Some of the key sectors are:

• Banking: Barclays (BARC), HSBC (HSBA)

• Beverages: Diageo (DGE), Fevertree (FEVR)

• Fossil Fuels: BP (BP), Petrofac (PFC)

• Media: ITV (ITV), Pearson (PSON)

• Medicine and Biotech: AstraZeneca (AZN), GlaxoSmithKline (GSK)

• Retailers: Marks & Spencer (MKS), WH Smith (SMWH)

• Telecommunications: BT Group (BT), Vodafone (VOD)

• Tobacco: British American Tobacco (BATS), Imperial Brands (IMB)

 

Why do companies do an IPO?

An IPO (Initial Public Offering) is when a company issues its stock to the public for the first time — also known as going public.

The company uses the money raised from this process to cover expenses, pay down debt, or grow its business. An IPO also gives the company a lot of media attention.

Typically, large investment banks such as Goldman Sachs or Morgan Stanley handle the arrangements for the IPO. The company's shares then become available for public trading on the London Stock Exchange (LSE).

 

 

How do stocks work?

Stock prices rise or fall according to supply and demand. When there are more buyers, the price rises, and when there are more sellers, the price falls.

When you place an order to buy or sell a stock through an online brokerage, your broker sends it to an exchange or market maker. The broker's job is to fill your order at the best possible price.

Investors use different approaches to stock trading:

• Technical Analysis: Make buy or sell decisions by examining price charts and volume.

• Fundamental Analysis: Consider a company's financial statements and economic data such as GDP or employment reports.

Traders also differ according to their time horizon:

• Day traders: Complete a buy or sell trade in a single day.

• Swing traders: Hold positions for a few days or weeks.

• Long-term investors: Hold stocks for a year or more.

 

 

How to buy stocks?

Most people buy and sell stocks through a brokerage account. In the UK, many online brokers now offer trading with little or no commission.

Some platforms also offer fractional shares, which allow you to buy shares of expensive companies for a small amount of money.

Some companies also sell their stocks through a Direct Stock Purchase Plan (DSPP), which does not require a broker. However, as broker fees have come down considerably these days, DSPP has become less popular.

 

Concluding Thoughts

Investing in stocks is an effective way to build long-term wealth. If you understand how stocks work, what types of stocks are, and the right way to invest, you can get off to a strong start on your journey to financial freedom.