Understanding Stocks: A Beginner's Guide to Equity

Yesterday we learned about bonds, which are small slices of debt. Today Michael Fischer defines stocks, or small slices of equity:

The stock market has its own unique vocabulary, with “puts” and “calls”, “preferred stock” and “P/E ratios”, “dividends” and “spread”. I’ll cover more of these later, but for now here are some basic concepts.

Blue chip stocks are those from the oldest and largest companies, businesses like IBM and AT&T and Coca-Cola. They’re the backbones of the economy. Blue chip stocks are generally safe investments, though the potential returns may be lower. At the other extreme are penny stocks. These represent shares of new companies, or companies on shaky financial footing. Investing in penny stocks is highly speculative, carrying huge risk.

Growth stocks are from youngish companies that are — no surprise — growing rapidly. A value stock is one that investors believe may be trading at prices below market value. Large-cap stocks are from the biggest companies (blue chip stocks are all large-cap, I think). Small-cap stocks are from smaller companies.

Many established stocks pay dividends. As a company earns money, its board of directors will meet from time-to-time to decide what to do with the money. They may decide to return some of these earnings to the owners (the shareholders) in the form of dividends. Some stocks pay large dividends on a regular basis. These are called income stocks.

Tomorrow Michael describes stock market indexes; next week we move on to mutual funds.

Michael Fischer

Michael Fischer spent nine years at Goldman Sachs, advising some of the largest private banks, mutual fund companies and hedge funds in the world on investment choices. For more information, visit Michael's site, Saving and Investing, or purchase his book.

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