What a stock is and why it goes up or down
A stock is a small piece of a company. Its price changes because expectations about what that company will earn in the future change.
When you buy a stock, you buy a small part of a company's ownership. If a company has 1 billion shares and you own 100, you own a tiny but real part: you're entitled to a share of its profits (when it distributes them as dividends) and, in many cases, to vote at its shareholder meetings.
Why companies sell shares
A company that wants to grow needs money: to open factories, hire or buy other companies. It can borrow it (debt) or sell part of itself (shares). When it lists on the stock exchange for the first time it holds an initial public offering (IPO); after that, shares are bought and sold among investors on the exchange, and the company no longer receives that money.
How you make money with a stock
- Capital gains: you sell the stock for more than you paid.
- Dividends: the company distributes part of its profits to shareholders.
You can also lose: if the company does badly, its stock can fall a lot, and if it goes bankrupt, shareholders are the last to get paid (after employees, suppliers and lenders), so they can lose everything invested in that stock.
Why the price goes up or down
In the short term, supply and demand move the price: if more people want to buy than sell, it rises. But behind that is an idea: a company's value depends on the profits it will generate in the future. The price changes every time expectations about those profits change.
| What happens | Typical effect on the price |
|---|---|
| It reports better sales and profits than expected | Rises |
| It lowers its forecast for next year | Falls |
| Interest rates rise | Tends to fall, especially for growth companies |
| A competitor launches something better | May fall |
| The whole market drops on recession fears | Falls along with almost everything |
Price isn't the same as value
A $1,000 stock isn't "more expensive" than a $50 one: it depends on how many shares there are and how much the company earns. To compare, people use things like market value (price times number of shares) and multiples such as the P/E (price divided by earnings per share), which we cover in the fundamental analysis course.
Market value = share price × number of shares
Types of stocks by style
- Growth: companies growing fast and reinvesting almost everything; they usually trade at high multiples and move a lot.
- Value: mature companies that trade cheaply relative to their profits.
- Dividend: stable companies that pay out a large part of what they earn.
- By size: large (large cap), mid and small (small cap); small ones tend to be more volatile.
A single stock is risky
An individual company can fall 50% or more because of its own problem, even if the market is doing well. That's why many people combine individual stocks with funds or ETFs that hold hundreds of companies. We cover this in the risk and portfolio course.
Test what you learned
1. What do you buy when you buy a stock?
- A loan to the company
- A part of the company's ownership
- A product of the company
Show the answer
A part of the company's ownership. You become an owner, in a very small part.
2. A company reports record profits, but below what the market expected. What can happen?
- It always rises
- It can fall
- It never moves
Show the answer
It can fall. The price reacts against expectations, not against the record.
3. How is a company's market value calculated?
- Price × number of shares
- Sales × 10
- Profit ÷ employees
Show the answer
Price × number of shares. It's what the whole company is worth on the stock market.
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Everything in this section is educational: it explains how investing works, it doesn't tell you what to buy.