Jan 5, 2014

Stock Buy Break it Down - 1, The Basics

Rather than brewing one thick post on stocks, it'll be easier to digest if I cook up several shorter bites, each nibbling on one or two topics at a time.  We'll start with the basics then advance.  Here are the topics I'll cover this week in the stock series:

  • What is stock and how can it make us money 
  • Stock exchanges, New York and NASDAQ
  • Stock indexes, Dow Jones, S&P 500 and NASDAQ Composite
  • Mutual funds, money markets, bonds and gold
  • Risk vs. reward
  • Pick at stock charts and show what company fundamentals to pay attention to
  • Come with Pigtails as she purchases her first shares of stock! 

Today we'll define stock:  What in the heck is it and how can it pad our wallet/purse/murse?

10 years of the stock market

Stock Defined
Stock is a unit of ownership in a company.  Ownership means a stockholder may receive part of the company's profits.

A private company becomes public by registering to morph into a corporation.  

The advantage is equity injection, corporations raise money by selling shares of stock to investment banks and the general public.  

People that buy stock become shareholders/owners of the company.  

If a company makes a profit, they often return a portion of the booty to shareholders in the form of dividends (cash or additional shares of stock).  

Shareholders hold stock for some time, receive quarterly dividends, then (hopefully) sell the stock for more money than they paid for it.  This is how you make money without lifting a finger.  Well, other than tapping a few keys.

Private Company ---> Corporation Selling Stock  
Suppose I run a private company called Vault Case that makes smartphone cases.  I'd like to raise cash to expand my factory (Pigtails with a glue gun) to also begin manufacturing iPad cases.  The steps to sell stock go like this:
  1. Vault Case files paperwork with the SEC (Securities and Exchange Commission) to incorporate.  
  2. The SEC approves and my company becomes a corporation, yee haw.
  3. I work with an investment bank to select a stock exchange, either the New York Stock Exchange or NASDAQ.  We also decided on the number of shares to issue, and price per share.  We agree my stock symbol will be VCAS, listed on the NASDAQ for $15 per share.
  4. I perform a dog-and-pony roadshow to entice investment buyers, then we do a stock market launch via an IPO (initial public offering).  
  5. My IPO issues one million shares on the NASDAQ at $15 per share.  This raises $15 million for VCAS, which is enough to expand my factory (now Pigtails plus her friend and two glue guns) for making iPad cases.
  6. My hands are now washed of the stock thing.  All future buying and selling of VCAS shares is handled between brokerage houses and the general public.  I don't profit from any future stock gains.  My company is on the hook for dividend payouts to shareholders, if my company makes a profit and the board agrees to dividends.  
Stock Buyer Profit
Suppose I'm a stock buyer who'd like to purchase 100 shares of Vault Case (VCAS):
  1. Purchase 100 shares of VCAS at $15 per share via an online broker such as E-Trade.  This comes to $1,500, plus a $10 trading fee, for a total of $1,510.
  2. VCAS does well, turning solid revenue each year.  The company decides to return $400,000 to stockholders quarterly by issuing a dividend of 40 cents per share every three months.  This is $160 a year per 100 shares.
  3. Two years later, the shares are trading at $25 each.  I decide to sell all my shares and make bank.  The payout calc: 
         $2,500 stock sell price 
      -  $1,510 stock buy price
         $   990 profit
      + $   320 dividends
      = $1,310 payout

This $1,310 bounty is called capital gain.  Since I held the stock for more than one year, it's taxed at a lower rate of 15%.  $1,113 is the payout after taxes.   

Now imagine if you bought $10,000 in stocks and made $25,000 in profit.  Or $100K invested grows to a $500K payout.  A million dollar lotto win, it wouldn't be too much strain to double in short order.  

We're not wealthy and can only afford to buy a few stocks at a time.  So the pragmatic approach is consistently snag shares every few months or perhaps annually.  Hold for the long term and use dividends to purchase additional shares (rather than cash payout), which adds a compound growth factor to the pot.  

Next post we'll cover stock exchanges and stock indexes.

Holler in the comments if you have any questions!


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