Not only is investing in stocks the most popular form of investment out there, it is also arguably the simplest and easiest way to invest – if you know how to pick the right investment.We list the key things you need to know about investing in stocks.
What is a stock?
A company “stock” or “share” is a unit of ownership in the company. Companies raise money from private or public investors in return for partial ownership in the entity. Say for example, Company ABC has a paid up capital of AED10,000 divided into 10 shares with each unit priced at AED1,000. The company has now decided to double its capital to AED20,000 through issuance of 10 new shares priced at AED1,000. It could obtain the money by selling the new shares to 10 investors. In this scenario, Company ABC now owns only 50% of the pie. While each new investor now owns 5% (shareholding of AED1,000 divided by capital of AED20,000). We illustrate this example below:
|Initial capital (AED)||Company ABC ownership||Other shareholder ownership|
|AED 10,000 – 10 shares||100% (total of 10 shares)||None|
|Company ABC raises AED10,000 in fresh capital at AED1,000 per share|
|New capital (AED)||Total company ABC ownership||Total other shareholder ownership|
|AED 20,000 – 20 shares||50% (10 shares)||50% (10 investors own 1 share each)|
|10 new investors now each own 5% of Company ABC|
The beauty of stocks is that, unlike many other investment types, it is accessible to almost anyone with a little capital to spend. Even so, it still remains vastly misunderstood by a majority of the investing public since the bulk of your gains are made on the stock’s price movements. It is precisely this misunderstanding or miscalculation that makes a stock a potentially attractive purchase. We’ll explain why.
What determines a company’s stock price?
A company’s stock price can be affected by internal factors such as poor earnings, management changes, lawsuits etc. The inherent value of a stock is based on the quality of the company itself. However, stock prices often fluctuate according to external factors such as political changes, economic crises and natural catastrophes.
When should I buy a stock?
The movement of stock prices can allow you to make gains if you sell your stock at a higher price than that at which you bought it. That is why it is important to buy or sell at the right price. For example, based on the internal and external factors discussed above, you may be able to determine when to buy a stock. If a company’s future prospects look optimistic, external factors are favourable and the stocks are available for cheap, it may be time to buy. Research is one of the most important factors in deciding this. Look into what kind of products the company is selling and its profitability. Is the industry in growth or decline? You can then project its earnings and come up with a rough estimate of how much the company is worth today. There are several brokerage companies that do the calculations for you. These companies regularly produce research reports giving you insight into the company, its industry and what its stock value is. Typically, in a research report, you will see stock price valuation and investment recommendations including buy, hold or sell.
[Related:How to invest AED 100,000]
While you hold: earning dividends
In addition to gains from buying and selling stocks, you can earn an income by holding a stock. Sometimes, companies distribute a portion of their profits to shareholders. This is called a dividend. However, this is not necessarily a steady source of cash flow. Depending on the performance of the company, they may choose not to declare dividends in a given year. The best way to make an informed decision about your stock is to keep well-informed on all the major events in the company and industry. For example, you could read business publications such as the Wall Street Journal or Financial Times.
When to sell
The large gains from stocks are earned when they are sold. Unlike bonds, stocks do not have any maturity or expiry date. Deciding when to sell is entirely dependent on what your target return is from the investment. You may choose to hold the stock indefinitely, however, this will make deciding when to sell tougher. Waiting too long may also result in losing earnings as the price will start declining after reaching a peak.
What to watch out for
Stock prices could fluctuate due to any number of reasons. However, be wary of the temptation to sell during a temporary slump. As long as the fundamentals of how the company operates remains unchanged, your stock is still valuable even though the market may have fluctuated.
Regardless of what type of stock it is, the key is to buy low and sell high.