The stock market for beginners makes for an equally alluring and lucrative investment opportunity as much as it appears to be confusing and risky. The steep rise and fall of the markets are enough to send shivers down the spines of beginners. However, history has shown that investing in stocks has been one of the most profitable and easiest methods of building wealth over a long period. Hence, studying a few stock market basics can help beginners go a long way in investing wisely and correctly in building wealth. This stock market for beginners’ guide will explain the what, how, when and how much of investing in stocks –

What is stock?

A share of stock essentially denotes legal ownership (equity) in business. Stocks, which are also called as ‘equities’ and ‘securities,’ are usually of two types – common stocks and preferred stocks. Common stocks (or the stocks we hear about in investing) entitle owners to a proportional share of the particular firm’s gains or losses. Preferred stocks are economic equivalents of a quasi-bond/stock, and owners aren’t entitled to a cut of the gains and losses. However, they receive a specific dividend at predetermined times. Another important difference is that preferred stockholders are paid dividends before common stockholders, and in the event of the company going bankrupt, the preferred stockholders outrank common stockholders for recouping of investments.

Why are stocks created?
The chief reasons for stocks having been created are –

• Raise capital
• Stocks allow firms to raise capital that can be invested in various aspects of the business.
• Return on investment
• Stocks allow investors to earn returns on their investment which will help them achieve their own financial goals.
• Separate ownership and management
• Stocks allow those people who have no time, ability or the interest in running a company to still participate economically in it.
• Cushion
• Equity capital acts as a cushion for the lenders, and doesn’t have a guaranteed divided rate and doesn’t have a date by which it needs to be repaid either, reduces risk and cost of capital, resulting in higher profits.

How do investors make money off stocks?
This is one of the most widely asked questions in the FAQs for the stock market for beginners. Investors often make the mistake of aping other investment portfolios rather than working on their own to earn profits. Essentially, for one to make money off of stocks, they must consider the future value of the stock, which must be equal to the sum of the following three aspects –

• The price-to-earnings ratio;
• The growth in the intrinsic value per share; and
• The initial dividend yield as compared to the cost

The aspects mentioned above are the only three ways that investors in stock can benefit monetarily. Investors can either collect cash dividends, or they can share in the proportional growth of the underlying earnings per share, or they can earn more or less for every dollar of profit that the firm generates, driving the price-to-earnings ratio or valuation multiple.

How can someone invest in stocks?
The most pertinent question about stock market for beginners have – how to exactly invest in stocks? There are more than a few handful ways, which are listed below:

• Investing through the DRIP (direct stock purchase plan or dividend reinvestment plan);
• Investing through a brokerage account (taxable);
• Investing in numerous types of IRAs – SEP IRA, Simple IRA, Roth IRA or the Traditional IRA; or
• Investing through the employer’s 401(k) plan or a 403(b) plan in case you work for a non-profit organization.

How investors acquire stocks largely depends on the account through which they make the investment acquisition. For instance, if one is investing via a Roth IRA, Traditional IRA or a taxable brokerage account, they can have their brokers buy stocks (publicly-traded) of whichever companies they want. Another example would be investing via index or mutual funds, such as in a 401(k) account, which only acts as legal intermediary mechanisms holding stocks for investors.

Hence, while investing in stocks, investors need to decide whether they wish to hold stocks themselves or they wish to do so through intermediaries.

Which stocks to invest in?
This is probably one of the most-asked questions when it comes to stock market for beginners. Determining which stocks to include in one’s investment portfolio depends on many factors. A common error that beginners make is thinking that maximizing absolute return is the objective of any portfolio. For instance, objectives could also be to increase cash income or to minimize risks and achieve satisfactory returns. Listed below are how you should choose stocks to invest in –

• Stocks of businesses having a long, established history of increasing or sustained profitability through an entire business cycle, which includes at least one recession.
• Stocks of businesses that have a BOD and management that is not only shareholder-friendly but is also willing to distribute excess capital as share repurchases and dividends.
• Stocks of businesses that don’t have a very high investment in capital assets or working capital, and has high returns on tangible capital.
• Stocks of businesses that have a unique competitive advantage of any kind.
• Stocks of businesses that are trading at low price-earnings ratios.

After you list stocks, look at stocks that fit together in the portfolio and try offsetting correlated risk.