Understanding How Stocks Work: Stock Market Basics
In my previous blog, I discussed the five big reasons why people invest in stocks. If you have a difficulty understanding how stocks work, this article can be of help.
This article focuses on what a stock is and the factors that drive its prices.
Table of Contents
- What is a stock market and how does it work?
- What is a stock?
- How can you earn from the stock market?
- What drives the stock prices?
What is a stock market and how does it work?
Fruits, vegetables, meat, clothes, furniture. These are just a few of the common things you see in the market every day. A market, in general, is a place wherein goods or services are being traded for money.
The stock market is just like the market that you already know. But instead of fruits, vegetables, or meat, what is being sold here are stocks. That’s why it is called a stock market, obvious, isn’t it?
Read More: Are you prepared to invest?
What is a stock?
Let me tell you a story of a baker named Juan.
He is fond of baking pastries. Now, Juan wants to start his own bakeshop.
Juan just figured he needs 100,000 pesos in order to put up such business. That includes the cost of putting up the store, the cost of utensils, and the cost of labor he needs.
Juan has a problem though. He only had 70,000 pesos. He still needs 30,000 pesos in order to realize his dream business.
But instead of having loans which offer huge interest to pay, Juan thought of something better. He asked three of his friends, Pedro, Crispin, and Basilio to help him fund his business with 10,000 pesos each.
That makes three of his friends part-owners of Juan’s bakery.
If we are to compare the ownership of Juan’s Bakery into a piece of cake, this is how it will turn out:
After 5 years, Juan’s bakery grew its overall value from 100,000 pesos to 500,000 pesos. Since Juan’s three friends are still part-owners of his bakery, they get a proportional increase in their investments as well.
But what if Juan’s Bakery has gone bankrupt?
On the downside, if Juan’s bakery went bankrupt and his bakery’s total value went down from 100,000 pesos to 50,000 pesos. Juan and his friends would have lost 50% of their capital as well.
Relating Juan’s Bakery to the stock market
If we are to relate Juan’s bakery to the stock market, that would be companies like Jollibee, San Miguel, Ayala, BDO, and the other companies participating in the stock market.
Now, how would those companies participate in the stock market?
Take Jollibee Foods Corp. for example:
- Jollibee offers a part of its company ownership to the public. Such public ownership will be divided in the form of stock market shares. This makes the public’s ownership more measurable and more affordable to the stock market investors.
- Stock market investors buy shares of Jollibee (JFC).
- Jollibee uses such pooled capital from the public in order to expand its business.
A stock, therefore, is a financial instrument that signifies public ownership of a certain company.
Stock vs Share: What is the difference?
The terms stock and share are often used interchangeably. Though they offer the same concept, there is a slight difference.
A stock is a more general term while a share is a little bit specific.
When you say “I own stocks“. It can be a stock of any company. May it be Jollibee, Ayala, BDO, etc. No follow-up questions. That’s it. You’re a stock investor. Period.
But when you say “I own shares”, that could mean a little bit specific. You may be asked, “How many shares and of what company?” Then you’ll respond, “1,000 shares of Jollibee Foods Corp.”
A share is something that is measurable. Shares refer to how much of a company’s stock you possess.
But anyway, that doesn’t really matter. As long as we know the concept of stocks or shares, we can just use it interchangeably.
Read More: Four Ways to Invest in the Stock Market
What is a stock symbol?
A stock symbol is a set of letters or a combination of both numbers and letters used to identify a particular stock being traded in the stock market.
Stock symbols make the company stocks more memorable for the investors.
Jollibee Corp. for example has a stock symbol JFC.
BDO Unibank, Inc. has a stock symbol BDO.
San Miguel Corporation has a stock symbol SMC.
2GO Group, Inc. has a stock symbol 2GO.
And so on.
Other stock symbols in Philippine Stock Exchange can be found HERE.
Stock symbols are also useful not to confuse investors of the stocks being offered by the same company and its subsidiaries.
Take Ayala Corp. (AC) and Ayala Land (ALI) for example.
Ayala Corp. (AC) is the parent company while Ayala Land, Inc. (ALI) is Ayala Corp.’s subsidiary.
They are both Ayala companies but they differ from how they use the capital pooled from the stock market.
Ayala Corp. (AC) is involved generally in BPO services, transport infrastructure, education, healthcare, international, real estate, and financial services. Ayala Land, Inc. (ALI), on the other hand, is mainly involved in real estate.
How can you earn from the stock market?
There are basically two ways on how you can earn from the stock market. That is through (1) Price Appreciation and (2) Dividends.
Price Appreciation
Suppose you bought 100 shares of Jollibee Foods Corp. stock (JFC) at 100 pesos per share last 2012.
After seven years, the cost per share of JFC went up to 300 pesos.
Considering you are still holding the same number of shares, your 10,000 pesos would have increased to 30,000 pesos. That’s an overall gain of 200% or 20,000 pesos!
But what if Jollibee’s stock went down to 50 pesos each? Then you would have a total loss of 5,000 pesos.
Again, that’s the downside of stock market investing. Just like any businesses or any other investments, there are risks involved in stock market investing that you must be aware of. One of those is knowing that there is no guarantee that the stock’s price will rise over time.
Dividends
Huge companies involved in the stock market usually give dividends to the ones who are holding their stocks. Dividends serve as rewards to the company’s shareholders.
Dividends may be given yearly or quarterly in the form of cash or stock. This will greatly depend on the number of shares you possess. The greater the shares you hold, the bigger the dividends you get.
You have to take note that dividends are given according to the company’s discretion. Companies are not obliged to give dividends to their shareholders. Thus, not all companies involved in the stock market are giving dividends to their shareholders.
Here’s a tip. Most of the giant companies give dividends to their shareholders. So if you are after stock market dividends, you must look out for them!
If you are curious about which companies give the highest dividend yields, take a look at this list made by Equilyst Analytics.
What drives the stock prices?
You have probably seen this figure of a fluctuating trend even before you knew about stock market investing:
In reality, stock prices fluctuate from time to time. You may ask, what are the reasons why prices fluctuate then? Well, here are just some of those reasons:
1. Law of supply and demand
Just like any other market that you know, the stock market is highly driven by the law of supply and demand.
If the investors find a particular stock valuable or interesting, the more they will catch the stock at a higher price. The greater the demand, the more the investors are willing to pay just to own that stock.
On the other hand, if investors think a particular stock is not worthy to hold, there’s a great chance that the stock’s price will go down further. The investors are either selling their shares or are not simply interested to buy such particular stock.
2. Investors’ perception of the stock (speculations)
Market speculation is one of the factors that makes stock prices move like crazy. This can be due to certain price drivers such as news or company announcements. People are usually hyped by such drivers, making the stock price to go up or down abruptly.
3. Company’s financial health
If the company just announced a decrease in earnings, investors will less likely to invest in such particular company stock. Investors are always looking after companies having good financial standing, great potential earning, and consistent dividends.
Investing in financially healthy companies means having a financially healthy stock portfolio as well!
4. Industry information
If the government announced it will strictly prohibit mining, what do you think will happen to those stocks whose main business is linked with mining?
The investors will sell in panic.
Even if a particular company stock is doing good, there is a high chance that investors will start questioning its capacity if there are negative insights with regards to the industry it belongs to.
This can happen to any other industries or sectors such as real estate, conglomerates, energy, healthcare, consumer, commodities, and utilities.
5. Economic trends
Economic trends have a great impact on the stock market or in the economy in general.
For instance, if the inflation rate is higher than usual, it could cause a rise in prices of goods and services. It therefore denotes that the cost of living is high.
In effect, people will focus on necessities instead. They will less likely to invest their money. People will more likely to pull out their investments in order to make their ends meet as well, making the stock prices to generally fall.
Read More: Top 10 Best Investments for Beginners
Understanding How Stocks Work: A Summary
- Stock market is just like the market that you already know. But instead of fruits, vegetables, or meat, what is being sold here are stocks.
- The very basic concept of stock market investing is buying shares at low price and selling them at a significantly higher price. “Buy low, sell high.”
- A stock is financial instrument that signifies ownership of a certain company.
- A stock symbol is a set of letters or a combination of both numbers and letters used to identify a particular stock being traded in the stock market.
- There are two ways on how you can earn from the stock market: (1) Price Appreciation and (2) Dividends.
- There are five major factors that drive the stock prices: (1) Law of supply and demand, (2) Investors’ perception about the stock, (3) Company’s financial health, (4) Industry information, and (5) Economic trends.
If you find this article helpful, don’t forget to share it with your friends who want to learn more about stock market investing!
Previous Lesson: Why Do People Invest In Stocks? Here Are Five Big Reasons
Icon credits: The icons used in this article’s graphics were taken from Freepik.com, which can be found in the following links:
Sheila
Sheila is a civil engineer by profession but has switched careers to become a copywriter. She loves making sales through stories that are relatable to the average person. She's also a sucker for memes and thinks she’s the funniest person in the world (even though she knows that’s not true). Her favorite drink is Kopiko Brown coffee, but she'll also take tea or beer if it's offered.
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