When you buy a stock, you literally buy a share of a company, thus the term shareholder. Stocks can be categorized in a number of ways; a common way is based on value.
For example, large-cap stocks (IBM, Amazon, Ford, Johnson & Johnson) have market capitalizations of $500 billion+. They are typically the least risky because they have more cash on hand during rough times and are often industry leaders. Many of these companies also pay dividends to its shareholders.
Mid-cap stocks range from $1 to $5 billion in market cap (Starbucks, Foot Locker; Bed, Bath & Beyond). These companies may not be any riskier than large-caps, but potential for growth is generally less.
Small-cap stocks have less than $1 billion in market cap (Papa John’s, Boston Beer Co., 99 Cents Only Stores) and are the most volatile and/or risky of the three when it comes to investing in stocks. On the other hand, they have a lot of room to grow.
Investing in Stocks: What You Need to Know
You should only invest in stocks after you’ve done your homework to find out about a company you might be interested in. That could mean reading financial newspapers like the Wall Street Journal, basic investing books or websites like Wyatt Investment Research. Make sure you’re familiar with the focus of the business. Is it involved in a new technology or an established one? Is it a market leader? How has it performed over the past few months?
Tip #1: Never invest in just one stock.
Tip #2: Know you’re tolerance for risk.
Tip #3: Do your homework
You might even want to review a company’s most recent earnings report to see how stable and profitable it is. Some of the metrics used are:
- Price-to-earnings ratio (P/E)
- Price-to-sales ratio (PSR)
- Return on equity (ROE)
- Earnings growth
- Debt-to-asset ratio
- Free cash flow
It’s never a good idea to take someone’s word about investing in stocks or assume that because a co-worker has made a lot of money in one company that you will too.
Most importantly, never invest in just one stock. If a company goes bankrupt, so will your retirement account. You can diversify by buying many different size stocks or by investing in indices. For example, the S&P 500 is the 500 largest companies that trade on the New York Stock Exchange (NYSE).
Investing in stocks is not a game. Be smart, be cautious and don’t get greedy and profits will come your way.
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