Early on, we covered the need for insurance and emergency funds before investing. A brief history of the stock market and the role your broker plays when you buy or sell set the stage for our various investment choices. Nearly everything roots back to stocks so it’s here we begin.
Stocks by themselves are far too risky. It’s so easy to diversify your portfolio with mutual funds and ETFs that we should only buy individual stock under special circumstances and in limited quantities.
Buying stock means you’re buying a piece of a company. The stock price is determined by supply and demand. If there is demand for shares, the price will go up. If sellers start dumping shares and there aren’t enough buyers, the stock price will fall.
The number of shares issued during the IPO is basically what trades every day. If you take that number and multiply it by the price per share, you get that companies’ total market capitalization. In the future, we’ll talk about large cap, medium and small cap stocks. It’s simply a fancy way to describe big, medium or small companies.
The price of a stock is based on future earnings expectations. If a company is coming out with new products that are big sellers, their stock price should be on the rise. If a company makes replacement parts for 8 track players well…you know.
Comparing a companies stock price to its earnings gives us a P/E ratio. Don’t be overly concerned with the math but the lower the P/E ratio, the better. It’s a good way to compare companies in similar industries. It wouldn’t make sense to compare a computer maker to a restaurant chain. The P/E ratio is only for companies with earnings. If a company loses money every year, they won’t have one.