Stock Investing for Beginners
The basics of stock investing are so elementary that few people recognize them. When you lose track of the basics, you lose track of why you invested to begin with. Here's what's involved in stock market basics:
For the details on all of these concepts, and much more, check out my book Investing in Stocks For Dummies.
The bottom line in stock investing is that you shouldn’t immediately send your money to a brokerage account or go to a website and click a Buy Stock button. The first thing you should do is find out as much as you can about what stocks are and how to use them to achieve your wealth-building goals.
is a type of security that indicates ownership in a corporation and represents a defined portion (measured in shares) of that corporation’s future success. The two primary types of stocks are common and preferred:
Preparing to buy stocks
Gathering information is critical in your stock-investing pursuits. You should gather information on your stock picks two times: before you invest and after you invest. Obviously, you should become more informed before you invest your first dollar, but you also need to stay informed about what’s happening to the company whose stock you buy, as well as about the industry and the general economy.
When you’re ready to invest, you need to open a brokerage account. After you’ve opened a brokerage account, it pays to get familiar with the types of orders you can implement inside that account.
Knowing how to pick winners
When you get past the basics, you can get to the meat of stock picking. Successful stock picking isn’t mysterious, but it does take some time, effort, and analysis. And the effort is worthwhile because stocks are a convenient and important part of most investors’ portfolios.
Recognizing stock value
Imagine that you like eggs, and you’re buying them at the grocery store. In this example, the eggs are like companies, and the prices represent the prices that you would pay for the companies’ stock. The grocery store is the stock market. What if two brands of eggs are similar, but one costs $2.99 a carton and the other costs $3.99? Which would you choose? Odds are that you’d look at both brands, judge their quality, and, if they’re indeed similar, take the cheaper eggs. The eggs at $3.99 are overpriced.
The same is true of stocks. What if you compare two companies that are similar in every respect but have different share prices? All things being equal, the cheaper price represents a better buy for the investor.
But the egg example has another side. What if the quality of the two brands of eggs is significantly different, but their prices are the same? If one brand of eggs is stale, of poor quality, and priced at $2.99 and the other brand is fresh, of superior quality, and also priced at $2.99, which would you get? You would take the good brand because they’re better eggs. Perhaps the lesser eggs are an acceptable purchase at $1.99, but they’re overpriced at $2.99.
The same example works with stocks. A poorly run company isn’t a good choice if you can buy a better company in the marketplace at the same — or a better — price.
Comparing the value of eggs may seem overly simplistic, but doing so does cut to the heart of stock investing. Eggs and egg prices can be as varied as companies and stock prices. As an investor, you must make it your job to find the best value for your investment dollars. (Otherwise, you get egg on your face. You saw that one coming, right?)
Market capitalization and stock value
You can determine a company’s value (and, thus, the value of its stock) in many ways. The most basic way is to look at the company’s market value, also known as market capitalization (or market cap).
aren’t references to headgear; they’re references to how large a company is as measured by its market value. Here are the five basic stock categories of market capitalization:
From a safety point of view, a company’s size and market value do matter. All things being equal, large-cap stocks are considered safer than small-cap stocks. However, small-cap stocks have greater potential for growth.
Compare these stocks to trees: Which tree is sturdier, a giant California redwood or a small oak tree that’s just a year old? In a great storm, the redwood holds up well, whereas the smaller tree has a rough time. But you also have to ask yourself which tree has more opportunity for growth. The redwood may not have much growth left, but the small oak tree has plenty of growth to look forward to.
For beginning investors, comparing market cap to trees isn’t so far-fetched. You want your money to branch out without becoming a sap.
Although market capitalization is important to consider, don’t invest (or not invest) based solely on it. It’s just one measure of value. You need to look at numerous factors that can help you determine whether any given stock is a good investment.
Sharpening your investment skills
Investors who analyze a company can better judge the value of its stock and profit from buying and selling it. Your greatest asset in stock investing is knowledge (and a little common sense). To succeed in the world of stock investing, keep in mind these key success factors:
