When you purchase stock, you’re buying a part of a company. You receive a small portion of future profits and can vote for board members and other initiatives.

Stocks are sometimes referred to as “equities” because they represent a slice of a company’s “equity,“ or value.

Stocks differ from other investment types, such as bonds, in several important ways. They are not all the same, which is why it’s important to have a good understanding of the basics.

Key points

• Stocks represent a partial ownership of a publicly traded company.
• The majority of shares are traded on major exchanges like the NYSE or Nasdaq.
• Stock prices fluctuate depending on many factors, including the earnings performance of the company.

What is the stock exchange?

Stock markets are where shares in publicly traded companies can be bought and sold. They’re a place of central gathering (physical or virtual) for investors, traders and institutions to come together and exchange ownership. The stock market is a major part of the financial markets, and it includes currencies, commodities, bonds, and fixed-income securities. Stock exchanges connect companies that want to raise capital (by selling their shares) to investors who are looking to increase their wealth (by purchasing those shares). The New York Stock Exchange and Nasdaq are two of the most famous examples.

The stock market is not just a huge swap meet of stocks. It’s actually a complex system that relies on rules, intermediaries and pricing mechanisms. The market makers keep the trades flowing, while institutional investors such as mutual funds and pensions shape prices through their large trades. Individual investors add energy and emotion to the mix. Together, they help set prices, reflect expectations, and allocate capital across the entire economy.

What is my share of the total?

The size of a shareholder’s stake is determined by the number of shares issued and the size of the company.

For example, ABC Inc. may have 10,000 outstanding shares if you buy 100 shares. Congratulations! Congratulations!

As an investor, you typically only hold a small fraction of what the biggest companies are worth. There are currently 2.8 billion outstanding shares of the retail giant Walmart, while Apple has more than 16 billion.

How to trade stocks and IPOs

Today, almost all equity trading is done “screen-based“ or over computerized networks. Buy and sell orders are electronically matched, allowing for faster and more efficient trading. Investors can access the market virtually in real-time.

Exchanges are referred to as a “secondary market”. A company will usually hold an initial public offer (IPO) before a stock is available to trade on an exchange. This involves selling shares first to investors outside the company. It is called going public. Private companies can go public for many reasons. However, the main reason is to raise capital for investment in the business.

Earnings, price and value of an equity

Companies that are publicly traded report their earnings a few days after the end of each quarter. A company might report its earnings for the quarter January-March in late April or mid-April. Earnings per Share (EPS), whether they are expected or actual, is a crucial performance indicator and driver of stock prices for many companies. Investors should pay close attention to EPS figures.

Analysts who closely follow a particular company will often release forecasts per share that influence the expectations of the market. Imagine ABC Inc. was expected to earn $1 a share for its current quarter. However, it reported earnings of $1.10 a share. This is referred to as achieving “beat“ earnings in Wall Street speak. A positive surprise like this could boost the stock price. If the company fails to meet expectations and only reports 90 cents in earnings per share, then the stock price could drop dramatically.

Stock prices and company earnings are key inputs to other fundamental indicators, such as the price-to-earnings (P/E ratio) ratio. Markets may consider a company with a lower P/E than others in the same industry to be “cheap“ or undervalued. A high P/E can indicate that the stock is overvalued and, therefore, a riskier investment.

Note: A high P/E could also be indicative of high growth prospects in the future. As technology advances, profits increase, and companies begin to sell products, P/E ratios tend to drop. The P/E of electric carmaker Tesla has been decreasing as vehicle production increased in recent years. Amazon’s (AMZN) P/E was high a decade ago but fell as the company’s e-commerce division and web services divisions became profitable.

The benefits and risks of stock ownership

Stocks in companies with good management, products or services that are widely used or increasing in demand, and good management can generate better returns over the long term than CDs or savings accounts. The U.S. Stock market has consistently outperformed other types of investments over long periods. In the last 140 years, U.S. stock prices have averaged an annual return of 9.2%. Some companies pay a quarterly or a yearly dividend to investors, which is a percentage of their funds.

Stocks can do better or worse than the market as a whole. If you invested $5,000 in 100 shares of ABC Inc. and the stock traded at $60 a year after, you would have made a profit of $1,000 or 20%. If the stock fell to $40, however, you would be out $1,000.

Even if an organization is consistently profitable, it doesn’t mean that its shares aren’t susceptible to the whims of the market or events in the real world beyond the control of anyone – such as recessions, pandemics, geopolitical issues, and weather. If the overall market sentiment is negative (i.e. “bearish”), it can quickly bring all stocks with it.

The Bottom Line

Stocks are public companies, big and small. They represent those who power the global economy today and those who will someday. Stocks cover a wide range of industries, including retail, apparel, food and beverages, energy, technology, manufacturing and everything else in between.

As an old Wall Street saying goes, the stock market is both a market of stocks and a stock exchange. There are many moving parts, and smart investors will do their research before investing.