Monday Morning Quarter-Buck
"Success is a lousy teacher. It seduces smart people into thinking they can't lose." – Bill Gates
I had a great conversation with a client this past week about "learning" how to invest so that our conversations would be more engaging. This prompted me to ask a few more clients if they would be interested in an investment 101 series for the month of February; the feedback I received was a resounding YES. I've broken the series down into four-parts:
- What exactly is a stock?
What exactly is a bond?
What is a mutual fund?
What is the difference between a mutual fund and an exchange-traded fund?
If you have other questions about investing you'd love to have answered, let me know, I'll weave them into the series!
Investopedia defines a stock as, " a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. There are two main types of stock: common and preferred." Today I will discuss common stock only.
When you own stock, you own a piece of the company. The risk you take by owning the company is that it could cease to operate, or not "perform" as well as another company you could have invested in. Common stocks are the low man on the totem poll. If the company fails, you will be the last to receive anything out of the liquidation of the assets.
In my opinion, picking a stock is a lot like picking out any purchase you make. You need to ask yourself, why would I want this, what will I get out of it, and will it add value to my life?
When you think about those three questions, consider the risk involved too. When you buy a "proven" product, you know there is still room for a malfunction, but when you buy something that is newer to the industry, you aren't really sure if it's going to do what you want it to do.
Stocks are also like people in a way, they come in all sorts of shapes and sizes:
- Mega Cap - these are the largest companies market capitalization of $200 Billion or more;
Large Cap - these companies have a market capitalization of between $10 Billion and $200 Billion;
Mid Cap - these companies have a market capitalization of between $2 Billion and $10 Billion
Small Cap - these companies have a market capitalization of between $300 Million and $2 Billion.
You will often hear that the smaller the company, the larger the risk; but it also depends on the maturity of the company, among other things, so although that is generally true, it is not always true.
Another "mystery" that many don't understanding is the difference between value and growth labels. When you are reading that a company is considered a "growth" company versus a "value" company, what does that really mean? Generally, but not always, growth companies are more likely to reinvest their profits back into the company, in order to grow it. Whereas, value means that the company price might be less than what company is "fundamentally" worth - in other words, it is believed to be on sale.
Also, like people, companies mature and may start out as a small company and grow to a mega cap; an example would be Microsoft. They were "born" in 1975, growing from a small home-based business all the way up to Mega Large Cap Growth oriented company (I've also seen them labeled as value oriented), that pays a dividend of approximately 2.3% on your investment. Think of the risk a person would have taken by investing in this unknown technology back in 1975! Today, we consider them relatively low risk (for a stock) as most of us depend upon the product, understand the reputation, and rely on the company to help us operate our lives.
As always, wishing you a wonderful week!