Typically, an inventor has a great idea, then teams up with—or becomes—an entrepreneur.

The entrepreneur’s job

is to build a company that can make the invention a reality. The company needs to find the resources to make the
product and sell it widely enough to pay for those resources and to create a profit, making the whole effort
worthwhile. No matter how great the idea is, if it can’t be done profitably, it can’t be done.
As an investor, you buy stocks hoping to share in corporate profits, benefiting directly from the inventive vitality of
the economy and participating in economic growth. Understanding what stocks are, where they come from, what
they do, and how they have value will help you decide how to include stocks in your investment portfolio and how to
use them to reach your investment goals.
Resources have costs, so a company needs money, or capital, which is also a resource. To get that start-up capital,
the company could borrow or it could offer a share of ownership, or equity, to those who chip in capital.
If the costs of debt (interest payments) are affordable, the company may choose to borrow, which limits the
company’s commitment to its capital contributor. When the loan matures and is paid off, the relationship is over.
If the costs of debt are too high, however, or the company is unable to borrow, it seeks equity investors willing to
contribute capital in exchange for an unspecified share of the company’s profits at some time in the future. In
exchange for taking the risk of no exact return on their investment, equity investors get a say in how the company is
run.

Stocks and Stock Markets

Stock represents those shares in the company’s future and the right to a say in how the company is run. The
original owners—the inventor(s) and entrepreneur(s)—choose equity investors who share their ideals and vision for
the company. Usually, the first equity investors are friends, family, or colleagues, allowing the original owners
freedom of management. At that point, the corporation is privately held, and the company’s stock may be traded
privately between owners. There may be restrictions on selling the stock, often the case for a family business, so
that control stays within the family.

If successful, however, eventually the company needs more capital to grow and remain competitive. If debt is not
desirable, then the company issues more equity, or stock, to raise capital.
The company may seek out:
an angel investor venture capital firm private equity firm
Such investors finance companies in the early stages in exchange for a large ownership and management stake in
the company. Their strategy is to buy a significant stake when the company is still “private” and then realize a large
gain, typically when the company goes public. The company also may seek a buyer, perhaps a competitive or
complementary business.
Alternatively, the company may choose to go public, to sell shares of ownership to investors in the public
markets. Theoretically, this means sharing control with random strangers because anyone can purchase shares
traded in the stock market.
Going public requires a profound shift in the corporate structure and management. Once a company is publicly
traded, it falls under the regulatory scrutiny of federal and state governments, and must regularly file financial
reports and analysis. It must broaden participation on the board of directors and allow more oversight of
management. Companies go public to raise large amounts of capital to expand products, operations, markets, or to
improve or create competitive advantages. To raise public equity capital, companies need to sell stock, and to sell
stock they need a market. That’s where the stock markets come in.
Primary and Secondary Markets
The private corporation’s board of directors, shareholders elected by the shareholders, must authorize the number
of shares that can be issued. Since issuing shares means opening up the company to more owners, or sharing it
more, only the existing owners have the authority to do so. Usually, it authorizes more shares than it intends to
issue, so it has the option of issuing more as need be.
Those authorized shares are then issued through an initial public offering (IPO). At that point the company goes
public. The IPO is a primary market transaction, which occurs when the stock is initially sold and the proceeds go
to the company issuing the stock. After that, the company is publicly traded; its stock is outstanding, or publicly
available. Then, whenever the stock changes hands, it is a secondary market transaction. The owner of the stock
may sell shares and realize the proceeds. When most people think of “the stock market,” they are thinking of the
secondary markets.
The existence of secondary markets makes the stock a liquid or tradable asset, which reduces its risk for both the
issuing company and the investor buying it. The investor is giving up capital in exchange for a share of the
company’s profit, with the risk that there will be no profit or not enough to compensate for the opportunity cost of
sacrificing the capital. The secondary markets reduce that risk to the shareholder because the stock can be resold,
allowing the shareholder to recover at least some of the invested capital and to make new choices with it.
Meanwhile, the company issuing the stock must pay the investor for assuming some of its risk. The less that risk is,
because of the liquidity provided by the secondary markets, the less the company has to pay. The secondary
markets decrease the company’s cost of equity capital.
A company hires an investment bank to manage its initial public offering of stock. For efficiency, the bank usually
sells the IPO stock to institutional investors. Usually, the original owners of the corporation keep large amounts of
stock as well.
What does this mean for individual investors? Some investors believe that after an initial public offering of stock, the
share price will rise because the investment bank will have initially underpriced the stock in order to sell it. This is
not always the case, however. Share price is typically more volatile after an initial public offering than it is after the
shares have been outstanding for a while. The longer the company has been public, the more information is known
about the company, and the more predictable its earnings are and thus share price.
When a company goes public, it may issue a relatively small number of shares. Its market capitalization—the total
value of its outstanding shares—may therefore be small. The number of individual shareholders, mostly institutional
investors and the original owners, also may be small. As a result, the shares may be “thinly traded,” traded
infrequently or in small amounts.

Thinly traded shares may add to the volatility of the share price. One large shareholder deciding to sell could cause
a decrease in the stock price, for example, whereas for a company with many shares and shareholders, the actions
of any one shareholder would not be significant. As always, diversification—in this case of shareholders—
decreases risk. Thinly traded shares are less liquid and riskier than shares that trade more frequently.
Common, Preferred, and Foreign Stocks
A company may issue common stock or preferred stock. Common stock is more prevalent. All companies issue
common stock, whereas not all issue preferred stock. The differences between common and preferred have to do
with the investor’s voting rights, risk, and dividends.
Common Stock
Common stock allows each shareholder voting rights—one vote for each share owned. The
more shares you own, the more you can influence the company’s management.
Shareholders vote for the company’s directors, who provide policy guidance for and hire the
management team that directly operates the corporation.
After several corporate scandals in the early twenty-first century, some shareholders have
become more active in their voting role.
Common stockholders assume the most risk of any corporate investor. If the company
encounters financial distress, its first responsibility is to satisfy creditors, then the preferred
shareholders, and then the common shareholders. Thus, common stocks provide only
residual claims on the value of the company.
In the event of bankruptcy, in other words, common shareholders get only the residue—
whatever is left after all other claimants have been compensated.
Common shareholders share the company’s profit after interest has been paid to creditors
and a specified share of the profit has been paid to preferred shareholders. Common
shareholders may receive all or part of the profit in cash—the dividend. The company is
under no obligation to pay common stock dividends, however. The management may decide
that the profit is better used to expand the company, to invest in new products or
technologies, or to grow by acquiring a competitor. As a result, the company may pay a cash
dividend only in certain years or not at all.
Preferred Stock
Shareholders investing in preferred stock, on the other hand, give up voting rights but get
less risk and more dividends. Preferred stock typically does not convey voting rights to the
shareholder. It is often distributed to the “friends and family” of the original founders when the
company goes public, allowing them to share in the company’s profits without having a say in
its management.
As noted, preferred shareholders have a superior claim on the company’s assets in the event
of bankruptcy. They get their original investment back before common shareholders but after
creditors.
Preferred dividends are more of an obligation than common dividends. Most preferred shares
are issued with a fixed dividend as cumulative preferred shares. This means that if the
company does not create enough profit to pay its preferred dividends, those dividends
ultimately must be paid before any common stock dividend.
For the individual investor, preferred stock may have two additional advantages over common stock:

Less volatile prices

More reliable dividends

The economist John Maynard Keynes (1883–1946) famously compared the securities markets with a newspaper
beauty contest. You “won” not because you could pick the prettiest contestant, but because you could pick the
contestant that everyone else would pick as the prettiest contestant. In other words, the stock market is a popularity
contest, but the “best” stock was not necessarily the most popular.

Keynes described investing in the stock market as follows:

“The smart player recognizes that personal criteria of beauty are irrelevant in determining the contest winner. A
better strategy is to select those faces the other players are likely to fancy. This logic tends to snowball. After all,
the other participants are likely to play the game with at least as keen a perception. Thus, the optimal strategy is
not to pick those faces the player thinks are prettiest, or those the other players are likely to fancy, but rather to
predict what the average opinion is likely to be about what the average opinion will be.”

In the stock market, the forces of supply and demand determine stock prices. The more demand or popularity there
is for a company’s stock, the higher its price will go (unless the company issues more shares). A stock is popular,
and thus in greater demand, if it is thought to be more valuable—that is, if it has more earnings and growth
potential.
Stocks may be characterized by the role that they play in a diversified portfolio—and some by their colorful
names.
  Definition Role
Underestimated potential for Expect a higher rate of
Growth stock
growth. return.
Undervalued by the market; Expect a higher-than-
Value stock
underpriced. average return.
Less volatility than the overall Expect the value to fall less
Defensive stock market and less sensitive to than the market’s during a
market changes. market decline.
When the market rises,
More volatility than the overall expect the price to rise at a
Cyclical stock market and more sensitive to higher rate. When the
market changes. market falls, expect the price
to fall at a higher rate.
Expect the price to continue
Overvalued by the market;
Speculative stock rising for a time before it
overpriced.
falls.
Stock of a stable, well-
Blue chip stock established, large cap Expect stable returns.
company.
Widow-and-orphan Expect a steady dividend.
stock A blue chip defensive stock.
Expect the value to rise
Wallflower stock Overlooked and therefore when the stock is
underpriced. “discovered.”
Expect the value to rise if
Low-priced stock of a small or
Penny stock and when the company
micro-cap company.
succeeds.
Stock Market, as the name suggests, is just another type of the Financial market.
To further understand the market:

Suppose you own a company for so many years now. Then, you decided to extend it by building another branch in
the region. However, YOU LACK MONEY!
What will you do? Will you step back and wait until you save enough money before expanding?
Possible Solution!...
MAKE A POOL OF CAPITAL FROM THE PEOPLE.

For example, you need 10 Million Pesos to operate another branch of your business. Do you think a single
person would want to invest 10 Million Pesos in your company? Maybe! But there is a better way of raising
capital. YOU LOOK FOR MULTIPLE PEOPLE TO INVEST UNTIL THE 10 MILLION IS ATTAINED.

Impossible? Maybe.
If you took it as the whole 10 Million Pesos, Yes.
What if you take it as 1 million pesos each 10 investors?
How about 500,000 pesos each 20 investors?
100,000 pesos each 100 investors? Sounds attainable.
How can you make money in the stock market?

The simplest answer to this question is to

BUY LOW
and
SELL HIGH
Buy when the prices are low,
and sell at a higher price.

How is the stock price changing?

There are so many factors that influence the price of a stock.
Prices go up or down depending upon the supply and demand of the stock. It also depends on the economy.
EQUITY STRATEGIES
The best stock strategy is to know what you are looking for (i.e., what kind of stock will fulfill the role you want it to
play in your portfolio) and to do the analyses you need to find it. That is easier said than done, however, and
requires that you have the knowledge, skill, and data for stock analysis. Commonly used general stock strategies
may be long term (returns achieved in more than one year) or short term (returns achieved in less than one year),
but the strategies you choose should fit your investing horizon, risk tolerance, and needs. An important part of that
strategy, as with financial planning in general, is to check your stock investments and reevaluate your holdings
regularly. How regularly depends on to long- or short-term horizon of your investing strategies.
Long-Term Strategies
Long-term strategies favor choosing a long-term approach to avoid the volatility and risk of market timing. For
individual investors, a buy-and-hold strategy can be effective over the long run. The strategy is just what it sounds
like: you choose the stocks for your equity investments, and you hold them for the long term. The idea is that if you
choose wisely and your stocks are well diversified, over time you will do at least as well as the stock market itself.
Though it suffers through economic cycles, the economy’s long-term trend is growth.
By minimizing the number of transactions, you can minimize transaction costs. Since you are holding your stocks,
you are not realizing gains and are not paying gains tax. Thus, even if your gross returns are not spectacular, you
are minimizing your costs and maximizing net returns. This strategy is optimal for investors with a long horizon, low
risk tolerance, and little need for liquidity in the short term.
Direct investment and dividend reinvestment are ways of buying shares directly from a company without going
through a broker. This allows you to avoid brokerage commissions. Direct investment means purchasing shares
from the company, while dividend reinvestment means having your dividends automatically invested in more
shares (rather than being sent to you as cash). Dividend reinvestment is also a way of building up your equity in
the stock by reinvesting cash that you might otherwise spend.
Short-Term Strategies
Short-term stock strategies rely on taking advantage of market timing to earn above-average returns. Some
advisors believe that the stock market fluctuates between favoring value stocks and favoring growth stocks. That
is, the market will go through cycles when value stocks that are temporarily underpriced will outperform stocks of
companies poised for higher growth, and vice versa. If true, you would want to weight your portfolio with growth
stocks when they are favored and with value stocks when they are favored.
This value-growth weighting strategy relies on market timing, which is difficult for the individual investor. It also
relies on correctly identifying growth and value stocks and market trends in their favor, complicating the process of
market timing even further.
Day trading is a very short-term strategy of taking and closing a position in a day or two. Literally, it means buying
in the morning and selling in the afternoon. Day trading became popular in the 1990s when stock prices were riding
the tide of the tech stock bubble. At that time, it was possible to hold a stock for just a few hours and earn a gain.
Technology, especially the Internet, also made real-time quotes and other market data available to individual
investors at a reasonable cost. At the same time, Internet and discount brokers drove down the costs of trading.
Day trading declined, but did not die, after the tech bubble burst. It turns out that in a bubble, any strategy can make
money, but when market volatility is more closely related to earnings potential and fundamental value, there is no
shortcut to doing your homework, knowing as much as possible about your investments, and making appropriate
strategic choices for you.