How to Understand How Stocks Work

The stock market is well known to almost everyone, especially since the advent of tax-advantaged retirement accounts which encourage people to invest in high-return investments such as stocks. However, stocks and their values may be a bit mystifying to some. Since you shouldn't invest in things you don't understand, it may be worthwhile to investigate what stocks are and what give them value. In this article we are going to deal with publicly traded companies. Private companies, if organized as a corporation, will also have stock, but the stock is exchanged differently.

	First, we can define what stock is (also called a "share" in a company). Basically, the stockholders of a company are the owners of the company. (The CEO, president, and board of directors are not the owners, but rather anyone who owns a stock.) So, if you buy a stock, you are simply buying a piece of a company. Just as you and your friend can co-own a company (even if you don't work there and hire managers to run the company), you can buy stock in a company along with thousands or millions of others and be an owner of the company.
	Next, you need to understand what advantage it is to own the company. The most basic privileged is that you get to decide who runs the company (the board of directors). Each stock that you have will allow you one vote. If you want more power to select board members, then you buy more stock. Thus, owning stock gives you influence over the management of the company.
	Furthermore, a large value of a stock may come from its dividend, or the hope of a dividend in the future. A dividend is a cash payment of part or all of the company profits to the stock holders. For example, General Motors has, at least until recently, paid all the stockholders $.46 per share every 3 months. So if you own 1000 shares of GM, you would get a cash payment of $460.00 4 times per year. The dividend can change as often as the management sees fit and there is generally no guarantee of any dividend amount.
	Now, one can understand how the prices of stocks are determined. The price of a stock is determined by its perceived value. For example, if you are investing in a company that currently has never paid a dividend, but that is growing quickly, you may anticipate a future dividend. Thus, you might be willing to pay something now in anticipation of a future dividend. Similarly, if you anticipate that a company will do poorly in the future, either cutting dividends or shrinking, or even going out of business, you might not see their stock as so valuable anymore. Similarly, your outlook on the economy may affect how you think all companies as a whole are going to do, so you may be willing to pay more or less depending on your outlook on the economy. The price of a stock is the collective perceived worth of the stock by all the stockholders. Since many people will over-react to news about the company or the economy as a whole, this explains a large amount of the large daily fluctuations in stock price.

• There are more factors that affect prices. For example, if money for investing is easily available, then values go up. Or, if taxes on dividends are reduced, then dividends become more valuable (because you get to keep more of it), and that will make stock prices go up.

• Make sure you fully understand anything you invest in before investing in it. If you don't know where the money comes from, don't be surprised if it never comes.