Investing in the stock market is not as simple as going into a store to make a purchase. Buying stocks involves many steps: setting up a brokerage account, adding funds, and doing research. This helps ensure you know what you’re getting into prior to tapping the buy button.
Investing in stocks can be a great way to grow wealth over time. It can also allow you to gain more income through dividends, if you invest enough. Learn how to get started as well as the risks you should consider.
- Blue-chip stocks make good investments for new investors. This is because they're well-established names with reliable revenue.
- Value stocks seek relatively cheap stocks compared to the underlying business. They can make good first investments, as long as the company is fairly large and stable.
- If you want steady income, look at dividend stocks that pay you for holding onto them.
- Growth stocks offer the largest potential for gains out of the options described here. But they are also riskier, even more so when it comes to smaller firms.
Stocks in companies that are longtime market standbys are called blue-chip stocks. Even if they face negative press, they are old and sturdy; they are able to weather the storm. Blue chips are great for newer investors; they tend to move with the market predictably. They also carry less risk than most other stocks.
The S&P 500 tracks top companies in key industries in the large-cap segment of the market. Many of these are blue-chip stocks. These companies have flourished for years; they are reliable choices if you're new to investing.
A great example of a blue-chip stock is Walmart (WMT). The chain store has a history going back to 1962. It also has a huge market cap of $392 billion and relative stability compared to the market as a whole. And in 2020, with more than $500 billion in annual revenue, Walmart held the No. 1 spot on the Fortune 500 list.
The Fortune 500 is an annual list that compares U.S. corporations by total revenue. It's a great place to find blue-chip investment ideas.
Value investing is the idea that you can find undervalued stocks that look like attractive investments. You can do this through financial analysis methods. With this tactic, you can find and buy securities that are priced well below their true value. Value investing is the mantra of many famous investors; these include names such as Warren Buffett.
The S&P Global Index measures value stocks using three factors: the ratios of book value, earnings, and sales to price. Potential value stocks include American Airlines (AAL), Wells Fargo (WFC), and Expedia (EXPE).
Finding undervalued stocks is not always easy. One of the most useful metrics to look at is book value per share. This shows its assets compared to the current share price. Other popular ratios include:
- Price-earnings ratio (P/E ratio)
- Price-to-book ratio (P/B ratio, also known as price-equity ratio)
- Debt-to-equity ratio
- Unlevered free cash flow
Proceed with extra caution when it comes to investing in smaller firms. They are riskier and more volatile than older, stable-value stocks. Also, beware of those that have recently had a major price swing. Those swings and any recent news events surrounding them could influence various ratios and valuation methods.
Some people put their money into markets to see stock prices rise. Others care more about earning cash flow from their investments. If you want your stocks to pay you, dividends are the name of the game.
Dividends are a portion of a company’s revenue that is paid to shareholders. It's often done on a quarterly basis. They are often paid in cash. But sometimes investors will receive more stocks in the company instead. When looking for dividend stocks, look for a trend of steady dividends (or better yet, dividend growth) over time. This usually signals a financially healthy company with good long-term prospects.
Dividend Aristocrats is a term coined by S&P Global Indexes. These are firms that have increased their dividends every year for the last 25 consecutive years. Some of these include Verizon (VZ), Procter & Gamble (PG), and Philip Morris International (PM).
Dividend cutting is looked upon very negatively by the markets. It often follows a period of losses or decline. Be wary of any stocks that cut their dividends.
Keep an eye out for any dividend yields that are too high. Any stock paying a very high dividend should be looked at with a dose of skepticism. It could mean that investors expect the share price to drop or an upcoming dividend reduction.
To find current dividend yields, you can look at your brokerage account or free investment data websites. You can also look at a firm’s investor relations website, annual report, or required public filings for dividend information.
Growth stocks are measured using three factors according to the S&P Dow Jones Indices: sales growth, the ratio of earnings change to price, and momentum. Some companies that fit the criteria are Netflix (NFLX), Amazon (AMZN), and Facebook (FB).
Growth stocks have earnings that grow at a faster rate than the market average. In most cases, a start-up company in an area of interest is likely to be a growth stock. The technology sector is one example. Smaller companies and newer companies are riskier for investors. But some offer strong opportunities for growth.
Growth stocks can come out of any industry. High-tech companies in Silicon Valley have shown great growth prospects throughout the 21st century. These stocks can be companies of any size.
Larger growth stocks are often more stable and less risky. But they provide lower returns than the smaller, newer businesses with lots of room to grow.
Pros and Cons of Buying Stock
- Potential for growth to exceed inflation
- Possible revenue from dividends
- Option to pivot when market trends change
- Satisfaction of finding winning stocks
- Potential losses from unpredictable markets
- Unpredictable dividend payments
- Stress from underperforming stocks
- Difficulties identifying winning stocks
- Potential for growth to exceed inflation: Inflation is the rate at which the dollar loses value. It's a normal part of any economy. In the best case, your stocks earn a higher return than inflation. With many bank accounts, your money actually loses value due to inflation.
- Possible revenue from dividends: Some stocks pay dividends, or cash payments, to shareholders. They are usually fairly small on a per-share basis. But if you have a large portfolio, you may be able to earn a reliable income from your stocks.
- Option to pivot when market trends change: You can sell a stock with a few clicks on your computer or taps on your phone; this is far more simple than other types of investments. With stocks, if you want to change your portfolio, you have the option to do so at any time.
- Satisfaction of finding winning stocks: If you invest in single stocks, it feels great when you hit a winner. You may see your account balance skyrocket.
- Potential losses from unpredictable markets: There are no guarantees in the stock market. If you pick a bad company or invest at a bad time, it’s a risk. You could lose money.
- Unpredictable dividend payments: Most companies that pay dividends aim to follow a predictable schedule. But there’s always a chance that the economy struggles or new competitors move in. On occasion, payments or dividends may stop completely.
- Stress from underperforming stocks: It’s normal for your investments in your portfolio to fluctuate. But for many, this concept is stressful; it can be challenging to get used to.
- Difficulties identifying winning stocks: Actively managed investment funds employ highly educated people. They work regularly to beat the stock market. But most of the time, even they can’t do it. It’s often hard to pick the best stocks that will outperform the market.
Beware of Risky Investments
To avoid major losses, make sure to invest in a diverse portfolio of stocks. Invest across multiple industries and geographic locations. But before you buy any stock, review its recent performance, analyst opinions, competitors, and the future landscape.
If you think it is a solid business with good management and great prospects, it is a buy. If you have any concerns or reservations, hold off on clicking the buy button. Then, wait for a safer investment to come along.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.