Chapter 1

Surveying the World of Stock Investing

IN THIS CHAPTER

Knowing the essentials of stock investing

Getting ready to purchase stocks

Using what you know to pick successful stocks

While I work on this new edition of Stock Investing For Dummies, the stock market is near an all-time high (circa 38,000 for the Dow Jones Industrial Average and 5,000 for the S&P 500 in early 2024), which bodes well for stock investing. I think that you can find great stock investment opportunities in virtually any time period — even for newbies. Great stocks can help you build your wealth (through appreciation or providing income from stock dividends) in both up and down markets. In fact, a bear (or down) market can be a great time to buy stocks because they’re cheaper (think “sale!”). The key is knowing what to do (and even why) — but this book can help you with that.

Today’s stock market is a little puzzling, but it can still be rewarding. I can only promise you that if you read this book seriously, you’ll do much better than the average investor. The purpose of this book is not only to tell you about the basics of stock investing, but also to let you in on solid strategies that can help you profit from the stock market. Before you invest, you need to understand the fundamentals of stock investing, which I introduce in this chapter. Then, I give you an overview of how to put your money where it will count the most.

Understanding Investment Basics

The basics of stock investing are so elementary that few people recognize them. When you lose track of the basics, you lose track of why you invested to begin with. The following chapters in Part 1 can help you grasp these basics:

• Knowing the risk and volatility involved in stock investing: Perhaps the most fundamental (and therefore most important) concept to grasp is the risk (of losing money) that you face whenever you put your hard-earned money in an investment such as a stock. Related to risk is the concept of volatility. Volatility refers to a condition in which there is rapid movement in the price of a particular stock (or other security); investors use this term especially when a stock sees a sudden drop in price in a relatively short period of time. Find out more about risk and volatility in Chapter 4.
• Assessing your financial situation: You need a firm awareness of your financial starting point and where you want to go. Chapter 2 helps you take stock of your current financial status and your goals.
• Understanding approaches to investing: You want to approach investing in a way that works best for you. Chapter 3 shows you the most common approaches to investing.
• Seeing what exchange-traded funds have to offer: Exchange-traded funds (ETFs) are like mutual funds in that they have diversified portfolios, but you can trade them like stocks. I think that every stock investor should consider ETFs as a positive addition to their portfolio strategies since they offer benefits such as diversification and convenience. See Chapter 5 for the lowdown on ETFs.

Here’s the bottom line in stock investing: Don’t immediately send your money to a brokerage account or go to a website and click Buy Stock. First, find out as much as you can about what stocks are and how to use them so that you can achieve your wealth-building goals.

Before you continue, I want to clarify exactly what a stock is. A stock is a type of security that indicates ownership in a corporation and represents a defined portion (measured in shares) of that corporation’s future success. The two primary types of stocks are common and preferred:

• Common stock: This type of stock, which I cover throughout this book, entitles the owner to vote at shareholders’ meetings and receive any dividends that the company issues.
• Preferred stock: This type of stock doesn’t usually confer voting rights, but it does include some rights that exceed those of common stock. Preferred stockholders, for example, have preferential treatment in certain conditions, such as receiving dividends before common stockholders in the event of a corporate liquidation or bankruptcy. Additionally, preferred stock seeks to operate similarly to a bond for investors seeking stable income. (In this book, I mostly cover common stock, but I do talk about preferred stock in Chapter 9.)

In addition to stocks, I also cover exchange-traded funds (ETFs) in Chapters 5 and 13 because they can provide diversification (or instant exposure to an entire industry or sector with a single security) to a stock investor’s portfolio.

Preparing to Buy Stocks

Gathering information is critical in your stock-investing pursuits. Get the scoop on your stock picks at two different times: before you invest and after. Obviously, become informed before you invest your first dollar, but also stay informed about what’s happening to the company whose stock you buy, as well as about the industry and the general economy. To find the best financial information sources, check out Chapter 6.

When you’re ready to invest, you need to open a stock brokerage account. How do you know which broker to use? Chapter 7 provides some answers and resources to help you choose a broker (and that includes robo-advisors). After you open a brokerage account, it pays to get familiar with the types of orders that you can implement inside that account; find out more about placing orders in Chapter 17.

Knowing How to Pick Winners

When you get past the basics (see the preceding section), you can get to the meat of stock-picking. Successful stock-picking isn’t mysterious, but it does take some time, effort, and analysis. And the effort is worthwhile because stocks are a convenient and important part of most investors’ portfolios. Read the following sections and be sure to leapfrog to the relevant chapters to get the inside scoop on hot stocks.

Recognizing stock value

Consider stock purchasing like buying eggs at the grocery store. In this analogy, the grocery store is the stock market, the eggs are companies, and the prices for those eggs are the prices that you’d pay for the companies’ stock.

What if two brands of eggs are similar, but one costs $2.99 a carton and the other costs $3.99? Which would you choose? You’d probably look at both brands and judge their quality — and if they’re indeed similar, you take the cheaper eggs. The eggs at $3.99 are overpriced. You use the same thought process when buying stocks. What if you compare two companies that are similar in every other respect but have different share prices? All things being equal, the cheaper price represents a better buy for the investor.

But the egg example has another side. What if the quality of the two brands of eggs is significantly different, but their prices are the same? If one brand of eggs is stale, of poor quality, and priced at $2.99, and the other brand is fresh, of superior quality, and also priced at $2.99, which would you get? I’d take the good brand because they’re better eggs. Perhaps you’d consider the lesser eggs an acceptable purchase at $1.99, but they’re overpriced at $2.99. The same example works with stocks. Don’t buy stocks from a poorly run company if you can buy stocks from a better company in the marketplace at the same — or a better — price.

Comparing stock purchasing to buying eggs may seem overly simplistic, but doing so does cut to the heart of stock investing. Eggs and egg prices can be as varied as companies and stock prices. As an investor, make it your job to find the best value for your investment dollars. (Otherwise, you get egg on your face. You saw that one coming, right?)

Understanding how market capitalization affects stock value

You can determine a company’s value (and thus the value of its stock) in many ways. For the most basic way, just look at the company’s market value, also known as market capitalization (or market cap). Market capitalization is simply the value you get when you multiply all the outstanding shares of a stock (or total stock shares issued and available for investing) by the price of a single share. You can calculate the market cap easily; for example, if a company has 1 million shares outstanding and its share price is $10, the market cap is $10 million.

The terms small cap, mid cap, and large cap don’t reference headgear; they reference how large a company is, as measured by its market value. Here are the five basic stock categories of market capitalization:

• Micro cap (less than $300 million): These stocks are the smallest, and hence the riskiest, stocks available. (There’s even a subsection of micro cap called nano cap, which refers to stocks under $50 million. But I don’t talk about nano cap in this book because they are too small, too speculative, and not usually appropriate for beginning investors.)
• Small cap ($300 million to $2 billion): These stocks fare better than the micro caps when it comes to survivability and still have plenty of growth potential. The key word here is “potential” because these companies need to grow to prove themselves. Chapter 14...