Have you ever come across a “stonks” meme on your Facebook feed and wondered what stocks really are?
This word is what usually comes up in an investment conversation. Does it sound intimidating? Don’t worry, it’s one of the most common prejudices about stocks and we’re gonna break through that today (spoiler alert!). Most investors usually wonder about whether or not investing in stocks would be good for them. And maybe you are, too? But just like what we strongly advocate for in UP JFA, knowing and educating oneself is very important, no matter how you want to tackle your investment plans and journey. Your understanding of investment instruments and opportunities available to you plays a huge factor in determining how successful you are going to be in becoming financially independent. Thus, this article is written to help you steer clear of misunderstandings about stocks and guide you through your decision-making process. Whoever said that investing in stocks is only for experienced and savvy investors, right? Whether you plan to invest in it or just want to satisfy your curiosity about stocks, we got you!
Firstly, what are stocks?
A stock is a security that represents proportionate ownership in the offering institution or company. It is also known as equity. People who own stocks are either called stockholders, stakeholders, or shareholders. Owning a stock entitles the stockholder to a share of the issuing company’s earnings and assets. Now you might ask, why would companies want to give up a portion of their earnings to strangers? Companies issue stocks as a means of financing. In this case, companies are the “borrower-spenders” or institutions that need money and the stockholders are the “lender-savers.” A common reason why companies need financing is to raise funds or capital for business projects or operations (such as when a corporation plans to geographically expand its operations). In sum, stockholders pay to have ownership shares in the company to help them raise capital.
Stocks are traded on a stock exchange. A stock exchange is simply a marketplace where investors buy and sell stocks. Stocks can be traded in one or more exchanges. Famous stock exchanges you might have heard about are the New York Stock Exchange, Nasdaq, London Stock Exchange and the Japan Exchange Group. The Philippines also has its own national stock exchange, the Philippine Stock Exchange or the PSE. Publicly traded companies in the Philippines are listed in the PSE and there are 273 companies listed to-date. Curious about what companies are currently publicly-listed in the Philippines? Visit this page. The PSE has its own stock market index which is composed of 30 companies that represent the general movement of the Philippine stock market serving as the benchmark for measuring the Philippine stock market’s performance. This market index is called the Philippine Composite Index, or the PSEi (check out the PSEi list here).
Are stocks and shares the same?
These two words are usually regarded as synonymous and interchangeable by most people, but these aren’t actually the same thing. Here’s why: Stocks, as we’ve mentioned earlier, signifies ownership or a stake in a company. It is a more generic term referring to the issuing company itself. Shares, on the other hand, is a more specific term that refers to portions or quantities of a stock. For example, in the statement, “I bought 700 shares of San Miguel Corporation (SMC) Stock” the term “shares” is preceded by a number which points to the quantity of stock I bought, while the term “stock” is preceded by the issuing company I bought shares from. Basically, a stock is a collection of shares.
There are two kinds of stocks: Common and Preferred. Both stocks represent ownership in a company and can both be investments you can profit from. This means that you can either be a common stockholder or a preferred stockholder (or both!). The main difference between the two is their voting rights. Common stockholders have the power to decide on who they are going to place as the board of directors and have a voice when it comes to important matters regarding the company’s future. Preferred stockholders do not have this right. However, when it comes to the distribution of a company’s assets and earnings, as the name suggests, they are preferred over common stockholders. This means that they are given priority over dividends when the company is profitable and they are also paid before common stockholders when a company undergoes liquidation. In fact, preferred shares are similar to bonds in that preferred stockholders are usually guaranteed dividend payment forever. While common stockholders can still receive dividends, it is up to the board of directors to decide whether they will distribute dividends to common stockholders or not. In the event that a company needs to liquidate, it pays its creditors (or simply, the people or institutions they owe money to) first, next are its bondholders, then preferred stockholders, and lastly the common stockholders. This means that common stockholders will not receive any compensation or money until the preferred stockholders get paid. This is the reason why preferred stocks are considered to be less risky than common stocks. Lastly, like bonds or fixed-income investments, the par value of preferred stock is inversely related to market interest rates. Thus, as market interest rates go up, the par value of a preferred stock goes down and vice versa. A common stock’s price, however, is mainly determined by its demand and supply in the market. The diagram below shows a summary of the difference between a common and a preferred stock.
With all of this said, preferred stocks are very attractive to those who prefer a more stable and secure equity investment. This is because preferred stocks offer a fixed and steady income stream to its holders. It’s dividend payments are higher compared to those of common stocks and interest payments in bonds. Moreover, if you are a more conservative investor that wants to invest in stocks, preferred stocks are an ideal option for you to choose because you can protect your initial capital as it offers stronger bankruptcy protection than common stocks. The issuing company also pays back the initial investment when it is held until maturity. On the other hand, common stocks are more abundant on stock exchanges and while it’s riskier than preferred stocks, it also offers unlimited potential of getting higher returns as the issuing company becomes bigger and more profitable. What makes common stock attractive is its ability to dramatically increase in value over time, with the increases even going higher than 100% possible.
Are these the only categories of stock that exist?
Aside from what we’ve discussed above, there are two main categories of stocks that you can choose to invest in: Value stocks and Growth stocks. Value stocks is another term for undervalued stocks. What do we mean by undervalued stocks? Undervalued stocks are stocks whose prices are currently traded below their intrinsic or true value or worth. These are stocks that are believed to have the potential to grow and generate significant returns in the future. Value stocks are usually big and reputable companies such as the household names that we know of. These stocks usually also pay dividends well. Investing in value stocks is called value investing. Examples of value stocks are Coca-Cola, Procter & Gamble, and Johnson and Johnson. Growth stocks, on the other hand, are stocks that have a higher growth rate than the market average and thus generate profits faster than most stocks. These are basically companies that create profits faster than an average company in the same industry normally would. Companies that carry this kind of characteristic are promising in the sense that they introduced something innovative and have a strong competitive advantage. Growth stocks do not usually pay dividends to its stockholders, and if they do, dividends tend to be very small. Investing in growth stocks is called growth investing. Examples of growth stocks are Tesla, Netflix, and Facebook. (Can’t decide on which one’s better? This article presents an interesting comparison between the growth and value stocks and this one presents the two in the Philippine context!)
By now, you might be wondering how investors earn from stocks and there are two ways in which stockholders — both common and preferred — earn. First is through capital appreciation. Capital appreciation happens when the current value of a stock is higher than when it was bought. Investors benefit from this when they are able to sell a stock at a higher price than their actual buying price. Take Investor Steve as an example. Investor Steve bought 100 shares from SMC when the price was at Php 2.00 per share. He was able to sell his shares when the price was Php 3.00 per share. In total, he earned a profit of Php 100 from the stock through capital appreciation. Second, investors earn through dividends.
Dividends are a distribution of a fraction of a company’s earnings (or net profits) to its stockholders. Dividends are awarded to preferred stockholders while common stockholders may also receive dividends as decided upon its board of directors. Some companies do announce a periodic dividend payment to stockholders (i.e, annually, semi-annually or quarterly). Going back to Investor Steve’s example, Steve also owns shares in JFC and at the time when JFC declared cash dividends of Php 0.01 per share, Steve owned 100 shares from JFC so he was able to receive a dividend of Php 1.00 in total. This is how an investor owns from dividends.
Dividends may be paid out either through cash or stocks. Cash dividends are simply dividends paid out in the form of cash. Stock dividends, however, are dividends paid out in the form of additional shares. Here, the company issues new shares and distributes it to its existing stockholders. Recipients of stock dividends may choose to keep their new shares or sell it.
In a stock market, there are two main types of people: the Investor and the Trader. Before we differentiate the two, let’s discuss first their similarities. Investors and traders both aim to benefit and earn from stocks through participating in the market. They both buy stocks. Investors and traders also never enter the stock market and buy stocks blindly. Both require a plan or strategy to make the most out of their capital. The main reason for this is because both face the risk of not achieving their expected returns within their time frame or even losing their capital in the stock market.
As you’ve seen from the comparison above, there are different kinds of traders based on how long they actually hold their investments, which in this case, is stocks. Below we break them down for you.
No matter what category you fall (or might fall into), it is important to keep your head above water. Remember to educate yourself and establish discipline. While this article is written to introduce you to stocks (or should we say, stonks?), how you apply this knowledge would depend on your analysis.
Here’s something to look forward to: our next article will focus on fundamental and technical analysis (which we briefly mentioned here). You can also check out UP JFA’s Pisopedia to learn more. See you at the next one! 💚
- UP JFA Pisopedia