Quick disclaimer before I answer the question - I use Microsoft as an example in this post, but that is not to be construed as a recommendation to buy Microsoft stock. I rarely recommend investing in individual stocks and instead often opt for diversified funds with the individuals and families I work with. Please don’t make any investment decisions based on this post; instead, please consult with an advisor.
So, what is a stock? Simply put, a share of stock is a unit of ownership of a company. The more shares you own, the more of the company you own.
Companies don’t have infinite shares of stock - for instance, Microsoft (ticker MSFT) has around 7.4 billion shares of stock outstanding as of the date of this blog post. To buy one share, you’d need about $415.
So, technically, you could buy all of Microsoft with just about $3 trillion - this number is also known as the market capitalization (market cap, for short), and we get it by multiplying the price by the number of shares outstanding.
That’s part of what’s great about the stock market - if you want to own Microsoft, you don’t have to pony up $3 trillion (which, by the way, even the richest man in the world couldn’t afford). All you need is $415 - sometimes even less if you’re able to purchase a fractional share!
But why do stocks exist?
Well, companies sometimes need money to grow and expand their operations. When they want to grow, they have two options - take on debt (either from a bank or by issuing bonds to investors) or sell part of the company, by issuing stock.
It may seem a little counterintuitive - if you’re trying to make more money, wouldn’t you want to keep all of the ownership of the company? Maybe, but it’s also a way for current owners to de-risk and diversify their investments outside of their company.
You may be thinking “okay, great, now I know why companies issue stock, but why should I own stocks?”
The main reason is to make money over time - similar to if you were to own a business. Your goal would be to make money.
When you buy stocks, there are two main ways that you can make money.
The company pays a dividend, which is a portion of profits that the company decides to send to shareholders.
The stock price goes up - mainly because other people are willing to buy it at a higher price (supply and demand). Of course, if people aren’t willing to buy it at a higher price, or even at the same price, that would cause the price to decrease, and you’d lose money. A stock is typically more valuable as its profits or growth prospects increase.
Let’s consider an example:
Jim decided to buy Microsoft on January 2nd, 2023 for $243.08. Throughout the year, Microsoft paid 4 dividends out of profits. $0.68 on 2/15/23, $0.68 on 5/17/23, $0.68 on 8/16/23, and $0.75 on 11/15/23 for a total of $2.79 - about 1.15% of his initial investment, and almost enough to buy a latte!
But that’s not all he got. Microsoft closed out the year with a share price of $376.04. He made $132.96 in price appreciation! That’s almost 55% of his initial investment, and a lot more than just one latte!
In total, Jim made $135.75 from buying Microsoft.
Of course, this isn’t always the case. In 2022, investors in Microsoft lost $95.53 per share from the price going down, although they still made $2.54 from dividends.
This is what makes investing in stocks risky - Microsoft is an established, well known company, and the price can still vary wildly in any given year. Less established companies may even go out of business, in which case Jim would likely lose his whole investment.
Of course, that’s why diversification and investing for the long run is so important. Buying a basket of stocks is a way to have ownership in a number of different companies, all of which are doing the best they can to grow their profits.
Conclusion
Buying stocks is a way to benefit from owning companies without the headaches and risks associated with business ownership. Staying diversified and investing for the long-run allows the chance for investors to grow their money by investing in stocks.
As always, keep in mind that you don't have to go it alone. I’m Austin Preece, a financial planner in Eau Claire, Wisconsin, and I work virtually with people across the US. Check out my website to see what it's like to work with me and reach out if you have any questions.
If you found this post helpful, help spread the word! Share with friends and family that you think may benefit as well. But remember, this is solely for educational purposes - it's not advice.
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