- Stocks aren’t just pieces of paper.
When you buy a share of stock, you are taking a share of ownership in a company. Collectively, the company is owned by all the shareholders, and each share represents a claim on assets and earnings.
- There are many different kinds of stocks.
The most common ways to divide the market are by company size (measured by market capitalization), sector, and types of growth patterns. Investors may talk about large-cap vs. small-cap stocks, energy vs. technology stocks, or growth vs. value stocks, for example.
- Stock prices track earnings.
Over the short term, the behavior of the market is based on enthusiasm, fear, rumors and news. Over the long term, though, it is mainly company earnings that determine whether a stock’s price will go up, down or sideways.
- Stocks are your best shot for getting a return over and above the pace of inflation.
Since the end of World War II, through many ups and downs, the average large stock has returned close to 10% a year — well ahead of inflation, and the return of bonds, real estate and other savings vehicles. As a result, stocks are the best way to save money for long-term goals like retirement.
- Individual stocks are not the market.
A good stock may go up even when the market is going down, while a stinker can go down even when the market is booming.
- A great track record does not guarantee strong performance in the future.
Stock prices are based on projections of future earnings. A strong track record bodes well, but even the best companies can slip.
- You can’t tell how expensive a stock is by looking only at its price.
Because a stock’s value depends on earnings, a stock can be cheap if the company’s earnings prospects are high enough, while another stock can be expensive if earnings potential is dim.
- Investors compare stock prices to other factors to assess value.
To get a sense of whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria. Comparing a company’s performance expectations to those of its industry is also common — firms operating in slow-growth industries are judged differently than those whose sectors are more robust.
- A smart portfolio positioned for long-term growth includes strong stocks from different industries.
As a general rule, it’s best to hold stocks from several different industries. That way, if one area of the economy goes into the dumps, you have something to fall back on.
- It’s smarter to buy and hold good stocks than to engage in rapid-fire trading.
