Stocks
A stock is a small piece of ownership in a company. You share in its profits through dividends and a rising share price, and you share in its losses too.
How you earn
Two ways: dividends, which are profits paid out in cash, and price gains, when other investors are willing to pay more for the same share. Over long periods most of the return has come from companies growing their earnings.
What moves the price
- Earnings, and what investors expect them to be next year.
- Interest rates. Higher rates make future profits worth less today and make bonds a stronger competitor.
- Valuation. The same company can trade at 12 or 40 times its earnings depending on the mood of the market.
- The economic cycle, credit conditions and liquidity.
How it can hurt you
Broad stock markets have lost half their value more than once. The S&P 500 fell about 49% from 2000 to 2002 and about 57% from 2007 to 2009. Single companies can go to zero. Time in the market has historically smoothed this out, but recoveries can take years.
The rhyme
The Nifty Fifty, 1972–1974In the early 1970s investors piled into about fifty large, "one-decision" growth companies such as Xerox, Polaroid and Avon, often at 40 to 90 times earnings, because they were seen as too good to sell at any price. Then inflation and rising rates arrived. In the 1973–74 bear market the S&P 500 fell roughly 48%, and many of the favourites fell much further. Several were great businesses. They were simply priced for perfection.
Terms you will hear
- Dividend
- Part of a company's profit paid to shareholders.
- P/E ratio
- Share price divided by earnings per share. A rough gauge of how expensive a stock is.
- CAPE
- Price divided by the average of ten years of inflation-adjusted earnings. Smooths out the business cycle.
- Market cap
- Share price times the number of shares. The total value the market puts on a company.
- Index
- A basket that tracks a market, such as the S&P 500 or the MSCI World.
Educational content only. Not a recommendation to buy or sell. Past performance does not indicate future results.