I’m a big believer in education and meeting people exactly where they are in their financial journey. With about 20 years of experience as a financial planner, I’ve come across countless people who have so much fear and shame surrounding finances. So many people are convinced they “should know” all there is to know about personal finance and end up confiding in me that they are “stupid” when it comes to money matters. It breaks my heart! Personal finance is not taught in our schools and most parents don’t feel adequately prepared themselves to teach their children about finance. I tell my clients there are absolutely no dumb questions and remind them that I could never be a teacher or work in sales or work on the line in a manufacturing plant. I want my clients to be true “partners”: educated
and in agreement with every move we make together to ensure their financial success. If you have a degree in Finance, you’re going to want to skip this article, but if you’d like to take a deeper dive into understanding stocks, please read on.
A share of stock represents ownership in a company. If Acme Co. wants to build a new plant to make combines, they might decide to finance this project by issuing stock. Let’s imagine an example: Sarah has money in a savings account making less than 1.00% that she won’t need for expenses for many years. She is hoping to grow that money and so buys 100 shares of Acme stock at $ 10.00 per share for a cost of $ 1,000.00. Sarah is now a proud owner of a small slice of Acme Co. Let’s stop for a moment and dissect Acme as stocks are categorized in different ways.
One way stocks are categorized is by their size: large-cap, mid-cap, and small-cap. The “cap” stands for capitalization and is determined by multiplying the total number of company stock shares outstanding by their current market price. Large-cap companies have a total value figured in that manner of over $ 10 billion. These are the large companies that you hear about in the news and use their products and services. Mid-cap companies have values from $ 2 billion to $ 10 billion. Lastly, small-cap companies are those whose values are less than $ 2 billion. Many times, small-cap companies are newer or what you’ve heard referred to as “start-ups”. We need to bring risk and reward into the mix too. The smaller a company is, the more growth potential it might have, but its stock will also be the riskiest. All stocks move up and down in value according to sales, net profits, economic cycles, news, and investor emotions, but mid-caps move more and are riskier than large-caps and small-caps move even more and
are riskier than both other types. Some people decide to take on the extra risk of investing in small-cap stocks because they believe that a company has an emerging technology that they believe will make that stock a “winner” over time.
Stocks can also be defined as either growth stocks or value stocks. When a growth stock company makes money, they reinvest those funds into research and development or bigger, better plants and equipment. Some examples of growth stocks are technology stocks or cutting-edge biopharmaceutical stocks. Management and investors both are focused on and hoping shares of their company grow in value. Growth stock investors make money when the price per share of their company stock goes up. If
John bought 100 shares of a 2-year-old technology company at $ 5.00 per share and the price of the stock goes up to $ 15.00 per share after one year, John can decide to sell his stock for $ 1,500.00 (100 shares X $ 15.00) and make a profit of $ 1,000.00 ($ 1,500.00 – $ 500.00). He would have to pay what’s called a capital gains tax on his $ 1,000.00, but, currently, that is at a lower tax rate than the rate he would pay on his wages or interest earned on a C.D. Value stocks are a little different and are also known as dividend-paying stocks. When value stock companies make money, they may invest in plants, equipment or new technology, but they also wish to reward their shareholders in a special way by paying out what is called dividends. Dividends are a relatively small amount of money per each share of stock that is most often paid out to shareholders four times per year if the Board of Directors of that company vote to pay out that money. Shareholders who receive dividends must pay tax on those amounts, but the rate, like capital gains, is lower than ordinary income tax rates. Value stock company shareholders, then, can make money on their stocks two ways: from dividends and also from capital gains if the value of their stock goes up and they decide to sell it. Some examples of value stocks might be utilities or auto companies or other manufacturers.
If you’re a new stock investor, what do you do? Large-cap or small-cap? Growth or value? The key is to diversify…not putting all your eggs in one basket. A long-term investor needs a smart mix of stocks that will best serve her or his individual needs and that span several categories and industries.
I’ve been studying and investing in individual stocks for over 38 years and analyzing them is my passion! I’d love to partner with you in introducing a portion of your portfolio to stocks. Please call me at 563-949-4705 or email me at email@example.com.