Investment fundamentals: Stocks 101

What is a stock and why do people invest in them?

A stock represents a share of ownership in the issuing company. Stock ownership entitles the shareholder to a proportionate share of the company’s earnings. It also allows investors to vote in shareholder meetings and receive dividends (i.e. the company’s profits). Investors may also sell their stock to another investor. Companies sell stock to raise money to fund business operations. Stocks are mainly bought and sold on public stock exchanges.

Generally, investors purchase stocks in an effort to generate wealth over the long term. Some companies distribute part of their earnings to common stockholders in the form of dividends. In this case, investors may choose stocks based on their dividend payments in an effort to capture an income stream.

What are the risks associated with investing in stocks?

Just as stock ownership may offer potential benefits, it also comes with certain risks which include but are not limited to:

• Business risk: Poorly-run companies can fail, which can cause you to lose some or all of your investment.

• Market risk: Economic developments or other events can cause a decline in a stock’s value.
• Liquidity risk: You may not be able to sell stock quickly if there isn’t an interested buyer. This generally applies to small-cap stocks and is less of a risk for large cap stocks.
• Political risk: Unfavorable government action or social changes can affect stock prices.
• International/sector risk: A stock with operations in a particular country or sector may be more volatile.

Categories of stocks

Growth or value

• Growth stocks: A growth-oriented company is expanding rapidly or becoming increasingly more profitable. As the company enjoys greater success, its stock price should rise. Most investors buy growth stocks hoping to make a profit based on the increase in the company’s stock price. Growth-oriented stocks typically don’t pay large dividends.
• Value stocks: A value-oriented company is usually more established but has fallen out of favor with investors. Value stock is typically cheaper than growth stock. Investors buy a value stock hoping its price will rebound and they will realize a profit. Another reason investors buy value stocks is to create an income stream from the company’s stock dividend payments.

Market capitalization

Capitalization (cap for short) refers to the total value of all outstanding shares of a company’s stock.

• Large-cap companies, which make up about 70% of the U.S. stock market, tend to be more stable than small- or mid-cap companies.
• Mid-cap and small-cap companies each make up about 10% to 15% of the U.S. stock market. These stocks tend to have more growth potential than large-cap stocks but may be more risky.

Important information

Information provided by SEI Investments Management Corporation. This information is for educational purposes only and should not be relied upon by the reader as research or investment advice. Investing involves risk, including possible loss of principal.