Stock Basics: Part II
If you haven't yet already read Part I, I recommend that you do.
Even if you already have a basic grounding, I would like to ensure that we're on the same page.
In Part I, I covered the most basic pieces and context for understanding stocks as we know them today.
In this second part, I'm going to delve a little deeper into the different classes of stocks, stock splits, buybacks, and dividends.
In parts III and IV, I'll show further basics on stock options, how to value a stock ("valuation"), how to read financial statements, the process of buying and selling stock, basic chart analysis, more on basic investment strategies, and provide free resources where you can continue your education.
Classes of Stock When investing in stocks, the choices you make depend mostly on your investment goals, and your "risk-reward profile" - Wall Street gibberish for how much you're willing to risk for a certain amount of gain.
In order to measure all the various kind of stock, there are two broad categories to help.
They are:
Both healthcare- and consumer goods-related companies are great examples of this.
The reason these stocks tend to peform in a down economy is because people still need to eat, wash, and stay healthy during bad times as well.
It is also for this reason that these stocks are called "secular," because their growth happens separately from how the economy does.
Cyclical stocks, by comparison, tend to move with the market.
Auto makers, steel companies, and raw materials are examples of cyclical stocks.
The reason these stocks move with the market is because when people have extra money, they tend to buy more things, such as cars and houses.
The companies who supply the auto makers and home builders are also affected for obvious reasons.
Don't get me wrong - it's not that all stocks are either growth or cyclical.
Yes, some stocks do fall squarely within each of those categories, but there are lots of stocks that are somewhere in between.
For example, technology stocks in particular tend to be, what I call, "secular" secular stocks, because they can move independently of the economy, and of any other market forces that would normally act upon them.
Sectors and Industries I know that there's nothing like the word "sector" to make a person's eyes glaze over, but bare with me here.
Again, the point here is to give you the basics about stocks, and it's difficult to even overhear a discussion about stocks without the words "industry" and "sector" finding their way into the conversation.
Sectors are the big, umbrella category that a stock fits into.
Industries are a more specific.
If you've ever sold something on eBay, you'll know this concept very well.
To sell on eBay, you must first pick a general category for the item you're selling.
From there, you're able to pick sub-categories to more accurately describe your item.
In the world of stocks, sectors are the categories, and industries are the subcategories.
There are only 13 sectors into which all stocks can be categorized, and here's an easy way to remember them.
The Chicago Cubs do their spring training at Fitch Park in Mesa, AZ.
The words "Cubs" and "Fitch" create a handy acronym:
However, knowing the different sectors helps demystify the news, and put stocks in context.
Sectors are actually very important to track for successful investing.
In the subsequent parts of this series, I will go over more basic investment strategies, where you'll learn that 50% of how a stock moves depends on its sector.
Industries offer more ways to "slice and dice" the sector pie into more closely related kinds of stock.
While both Dolby Labs and VMWare are in the tech sector, they are in vastly different industries ("diversified electronics" and "technical & system software," respectively).
There are too many industries to remember, and honestly, a stock's industry has much less influence on its performance than its sector, but again, industries help to bundle similar companies.
Like the subcategories in eBay, it's much easier to find a stock based on its industry than having to go through its entire sector to find it.
Splits, Buybacks, and Dividends Splits A stock split is nothing more than when a company "splits" the amount of shares it has, and adjusts the value accordingly.
For example, if a company has 1 million shares outstanding, a "two-for-one" stock split would give it 2 million shares outstanding.
Two-for-one is the most common kind of split, however a company is free to split shares however they like.
There have been three-for-one and even three-for-two splits.
During a split, the value of the stock also adjusts so that it is a wash.
Using the same example, if the 1 million shares were worth $100 per share before the split, they would each be worth $50 after the two-for-one split.
The purpose of the split is to make more share available at a lower price in order to snag more investors.
It's as if the stock is having a sale, with - of course - no guarantee that it will return to its original value.
Investors see stock splits as very positive things, because stock tend to go up after they split.
Imagine the potential: you have 1000 shares of stock at $100 each.
If the stock splits to $50 and rises back up to $100, you'd now have 2000 shares at $100 each.
Your investment would have doubled at no extra cost to you! Companies can also do reverse splits, where they reduce the number of shares available.
While this increases the value of the outstanding shares, reverse splits are generally seen as bad news for the company.
Big institutional investors, like mutual funds and hedge funds, usually won't purchase stocks that are below a certain amount (like $5 a share).
In order to stay above that amount, a company with a low stock price may reverse split in order to push the stock price to or above that minimum.
Buybacks Another move companies can make is to buy back shares of their own company.
This is different from a reverse split in that the company's intent is generally positive.
When the company buys shares of itself, the company is essentially "putting its money where its mouth is.
" By buying shares of its own stocks, the company is saying that it strongly believes in its own profitability, and wants to make money from itself.
This is analogous to a political candidate voting for him/herself during an election.
The difference is that companies can buy as many "votes" as they choose! In the next part, I'll cover valuation, which is more Wall Street gibberish for figuring out how good a stock is.
Knowing whether or not a company is buying back shares is a key indicator when you valuate a stock.
I'll also show you where you can go to find out whether or not a company is doing that.
Dividends When a company makes a profit, it handles that money two main ways: either reinvest the extra money in the business, or pay out a dividend to its shareholders.
Typically, companies that can will pay out a dividend to its shareholders, as doing so makes the stock a very attractive offer to investors.
These dividends are paid to the stockholder in addition to any gains made on the stock itself.
They come in four flavors:
With cash dividends, if you are a shareholder of a company, you would receive an amount based on the value of all the shares you own.
So, for example, if you owned $10,000 worth of stock in a company, and that company declares a $0.
25 dividend, you would be paid $2,500.
Stock dividends work the same way, but the shareholders is paid with additional stock instead of cash.
The effect of being paid stock is similar to a stock split, in that the total number of shares goes up, but the value does not.
Most investors prefer to have the cash.
This is what Robert Kiyosaki refers to when he says that a stock must be profitable when you buy it, not when you sell it -- the dividend.
WARNING: Boring stuff here -- Property dividends are rare, but a corporation may pay out a dividend in the form of land.
This is usually done from a parent company to one of its subsidiaries, but it is not usual.
Even less usual are the "other" kinds of dividend payouts, which again usually involve a parent company and its subsidiaries, paying out particular assets a company may have.
This gets into the "structured finance" world, which involves corporations using smaller corporations to protect itself, and is definitely beyond the scope of this blog post.
Review
If any of this seems over your head, please contact me, and I'd be happy to help explain any of these concepts further.
My goal here is to give you the basics, so that as you make money from building your assets, you'll actually know what to do with it! Part III coming soon.
Thanks for reading.
Even if you already have a basic grounding, I would like to ensure that we're on the same page.
In Part I, I covered the most basic pieces and context for understanding stocks as we know them today.
In this second part, I'm going to delve a little deeper into the different classes of stocks, stock splits, buybacks, and dividends.
In parts III and IV, I'll show further basics on stock options, how to value a stock ("valuation"), how to read financial statements, the process of buying and selling stock, basic chart analysis, more on basic investment strategies, and provide free resources where you can continue your education.
Classes of Stock When investing in stocks, the choices you make depend mostly on your investment goals, and your "risk-reward profile" - Wall Street gibberish for how much you're willing to risk for a certain amount of gain.
In order to measure all the various kind of stock, there are two broad categories to help.
They are:
- Growth, also known as secular
- Cyclical
Both healthcare- and consumer goods-related companies are great examples of this.
The reason these stocks tend to peform in a down economy is because people still need to eat, wash, and stay healthy during bad times as well.
It is also for this reason that these stocks are called "secular," because their growth happens separately from how the economy does.
Cyclical stocks, by comparison, tend to move with the market.
Auto makers, steel companies, and raw materials are examples of cyclical stocks.
The reason these stocks move with the market is because when people have extra money, they tend to buy more things, such as cars and houses.
The companies who supply the auto makers and home builders are also affected for obvious reasons.
Don't get me wrong - it's not that all stocks are either growth or cyclical.
Yes, some stocks do fall squarely within each of those categories, but there are lots of stocks that are somewhere in between.
For example, technology stocks in particular tend to be, what I call, "secular" secular stocks, because they can move independently of the economy, and of any other market forces that would normally act upon them.
Sectors and Industries I know that there's nothing like the word "sector" to make a person's eyes glaze over, but bare with me here.
Again, the point here is to give you the basics about stocks, and it's difficult to even overhear a discussion about stocks without the words "industry" and "sector" finding their way into the conversation.
Sectors are the big, umbrella category that a stock fits into.
Industries are a more specific.
If you've ever sold something on eBay, you'll know this concept very well.
To sell on eBay, you must first pick a general category for the item you're selling.
From there, you're able to pick sub-categories to more accurately describe your item.
In the world of stocks, sectors are the categories, and industries are the subcategories.
There are only 13 sectors into which all stocks can be categorized, and here's an easy way to remember them.
The Chicago Cubs do their spring training at Fitch Park in Mesa, AZ.
The words "Cubs" and "Fitch" create a handy acronym:
- Consumer goods
- Utilities
- Basic materials
- Services
- Financial
- Industrial goods
- Technology
- Conglomerates
- Healthcare
However, knowing the different sectors helps demystify the news, and put stocks in context.
Sectors are actually very important to track for successful investing.
In the subsequent parts of this series, I will go over more basic investment strategies, where you'll learn that 50% of how a stock moves depends on its sector.
Industries offer more ways to "slice and dice" the sector pie into more closely related kinds of stock.
While both Dolby Labs and VMWare are in the tech sector, they are in vastly different industries ("diversified electronics" and "technical & system software," respectively).
There are too many industries to remember, and honestly, a stock's industry has much less influence on its performance than its sector, but again, industries help to bundle similar companies.
Like the subcategories in eBay, it's much easier to find a stock based on its industry than having to go through its entire sector to find it.
Splits, Buybacks, and Dividends Splits A stock split is nothing more than when a company "splits" the amount of shares it has, and adjusts the value accordingly.
For example, if a company has 1 million shares outstanding, a "two-for-one" stock split would give it 2 million shares outstanding.
Two-for-one is the most common kind of split, however a company is free to split shares however they like.
There have been three-for-one and even three-for-two splits.
During a split, the value of the stock also adjusts so that it is a wash.
Using the same example, if the 1 million shares were worth $100 per share before the split, they would each be worth $50 after the two-for-one split.
The purpose of the split is to make more share available at a lower price in order to snag more investors.
It's as if the stock is having a sale, with - of course - no guarantee that it will return to its original value.
Investors see stock splits as very positive things, because stock tend to go up after they split.
Imagine the potential: you have 1000 shares of stock at $100 each.
If the stock splits to $50 and rises back up to $100, you'd now have 2000 shares at $100 each.
Your investment would have doubled at no extra cost to you! Companies can also do reverse splits, where they reduce the number of shares available.
While this increases the value of the outstanding shares, reverse splits are generally seen as bad news for the company.
Big institutional investors, like mutual funds and hedge funds, usually won't purchase stocks that are below a certain amount (like $5 a share).
In order to stay above that amount, a company with a low stock price may reverse split in order to push the stock price to or above that minimum.
Buybacks Another move companies can make is to buy back shares of their own company.
This is different from a reverse split in that the company's intent is generally positive.
When the company buys shares of itself, the company is essentially "putting its money where its mouth is.
" By buying shares of its own stocks, the company is saying that it strongly believes in its own profitability, and wants to make money from itself.
This is analogous to a political candidate voting for him/herself during an election.
The difference is that companies can buy as many "votes" as they choose! In the next part, I'll cover valuation, which is more Wall Street gibberish for figuring out how good a stock is.
Knowing whether or not a company is buying back shares is a key indicator when you valuate a stock.
I'll also show you where you can go to find out whether or not a company is doing that.
Dividends When a company makes a profit, it handles that money two main ways: either reinvest the extra money in the business, or pay out a dividend to its shareholders.
Typically, companies that can will pay out a dividend to its shareholders, as doing so makes the stock a very attractive offer to investors.
These dividends are paid to the stockholder in addition to any gains made on the stock itself.
They come in four flavors:
- Cash
- Stock
- Property
- Other
With cash dividends, if you are a shareholder of a company, you would receive an amount based on the value of all the shares you own.
So, for example, if you owned $10,000 worth of stock in a company, and that company declares a $0.
25 dividend, you would be paid $2,500.
Stock dividends work the same way, but the shareholders is paid with additional stock instead of cash.
The effect of being paid stock is similar to a stock split, in that the total number of shares goes up, but the value does not.
Most investors prefer to have the cash.
This is what Robert Kiyosaki refers to when he says that a stock must be profitable when you buy it, not when you sell it -- the dividend.
WARNING: Boring stuff here -- Property dividends are rare, but a corporation may pay out a dividend in the form of land.
This is usually done from a parent company to one of its subsidiaries, but it is not usual.
Even less usual are the "other" kinds of dividend payouts, which again usually involve a parent company and its subsidiaries, paying out particular assets a company may have.
This gets into the "structured finance" world, which involves corporations using smaller corporations to protect itself, and is definitely beyond the scope of this blog post.
Review
- Classes of stock - growth (secular) and cyclical
- Sectors - general category to which a stock belongs ("CUBSFITCH")
- Industries - subcategories of sectors that help further classify stocks
- Splits - increases (or decreases) the number of shares while maintaining the overall value
- Buybacks - when a company purchases shares of its own company, generally positive
- Dividends - an amount paid to shareholders of a company, either in cash or stock
If any of this seems over your head, please contact me, and I'd be happy to help explain any of these concepts further.
My goal here is to give you the basics, so that as you make money from building your assets, you'll actually know what to do with it! Part III coming soon.
Thanks for reading.
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