Some early investors may not want to get involved in directly investing in stocks right off the bat. You can buy shares of mutual funds or ETFs which are essentially managed pools of money wherein another company invests in a wide variety of stocks and you get a portion of the returns. We’ll come back to that, but first let’s go over the basics of how individual stocks work and how you get returns on your investment.
Most people are aware of a stock’s price. Investors and analysts talk about a company’s price going up or down on the market in a given day. However, out of context, a stock price gives very little information about the health or value of a company. To truly understand how well a stock is doing, you need to look at a variety of factors. For that, we need some definitions.
Outstanding Shares – This refers to the total number of shares of a company held by all its investors. This number is used to calculate other key metrics like Earnings per Share and Price to Earnings ratio.
Dividends – Once a company reaches a certain level of stability and profitability, it can choose to start paying dividends. During a growth period, profits are usually reinvested in a company so it can grow more (which also benefits investors), but once growth stabilizes, a company can choose to pay dividends to shareholders. Shareholders can then choose to reinvest those dividends to get even more shares of stock.
Earnings Per Share – This is the amount of money that a company earns per share of stock. It’s calculated as a company’s net income minus dividends on preferred stock divided by the average outstanding shares. So, if a company makes $50m and there are 18 million shares outstanding, then one share is worth $2.78 worth of the company’s income.
Market Capitalization – Market cap is the current share price multiplied by all outstanding shares. This gives you a general idea of the size of a company. While getting the absolute value of a company is a bit more complicated than just looking at the market cap, for most basic research, comparing two company’s market cap can help you get a better sense of scale than a share price will.