Stock market basics

Ever seen a penny stock jump up 1000%?  I have, and it’s not a pleasant thing to look at if you don’t hold any shares in it.  However, before you start buying stocks, there are basic terminologies you should understand.  Also, to truly understand how well a stock is doing, you should read the news and understand the company’s financial reports.

First term you should understand is outstanding shares.  This refers to the total number of shares of a company held by all its investors. This number is used frequently when calculating rates like earnings per share and price to earnings ratio.

Another term you probably heard of is dividends.  Not all companies give out dividends, but when the company makes a lot of money, it can choose to start paying dividends to the shareholders. During a growth period, profits are usually reinvested in a company so it can grow more, but once growth stabilizes, a company can choose to pay dividends to shareholders.

Earnings per share is the amount of money that a company earns per share of stock. You can calculate this by company’s net income minus (dividends if any) divided by the average outstanding shares. So, if a company makes $10m and there are 2 million shares outstanding, then one share is worth $5 worth of the company’s income.

Market capitalization is the market cap for the current share price multiplied by all outstanding shares. This can give you a general idea of the size of a company.  Getting an exact estimate is much more complicated, but you can usually get a good estimate by just looking at the market cap.  You use this when you compare different companies.  For example, comparing two company’s market cap can help you get a better sense of scale than a share price will.

P/E ratio is a company’s current share price divided by its earnings per share. This will exhibit what investors are willing to pay per dollar of earnings. This can be used to see if the company is over or undervalued.

 

Now let’s talk about types of stocks.  There are two types of stocks, growth and dividends.  Growth is basically a type of stock that you would buy when the price is low and sell when it’s high to make a profit.  Remember that growth stocks can be both short term and long term.   Long-term capital gains from long term stocks are taxed at a lower rate than short term (long term is holding a share for more than a year) .  It’s 15% if you are in a 25% or higher tax bracket and only 5% if you are in the 15% or lower tax bracket.  Again, any profits from stocks held for less than a year are taxed at your ordinary income tax rate.

 

Unlike dividend stocks, growth stocks may have higher than usual volatility.  Higher the volatility, more money you will gain/lose.  Stock prices can easily jump from $1 dollar to $20 dollars and vice versa.  This may be risky for long term investors, so I would recommend stocks with lower volatility like ETFs (exchange traded funds) or a mutual fund (a mutual fund is a company that pools money from many investors and reinvests the money in securities such as stocks, bonds, and short-term debt) if you are in it for the long term.  These ETFs or mutual funds are already a diverse portfolio, so it wouldn’t be as volatile.

However, if you are still interested in growth stocks, try to make your portfolio diverse.  This means that you should not only invest in growth stocks, but in dividend stocks as well.  Try to invest in not only one company, but multiple companies at a time.

Dividend stocks are usually companies that have reached it’s plateau.  For example, you can bet that google isn’t going to go out of business any time soon. Since the company makes enough money to reinvest and still have some leftover, it pays dividends. In other words, the company pays you money for being an investor.

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