From my post yesterday, Stocks 101,we’re familiar with what stocks are, but how do you go about owning them?

Unless you work on a stock exchange, generally stocks are purchased through a stock broker who buys stocks through the exchange on your behalf.  The broker may be an actual person who you deal with at your financial institution or investment company and place orders through them or, quite commonly now, it could be an online broker where you place the orders on your computer.  The broker then charges you fees for placing the order.  The price varies from broker to broker, and can depend on a number of things like the number of shares purchased, how frequently you trade (buy or sell) shares, and the value of your account with the broker.

If you’re only looking to purchase shares and don’t need any advice, then you’ll most likely want a “self-directed” portfolio at an online brokerage.  They tend to have the lowest fees for trading because you’re executing trades on a computer instead of with a live person, and there is more automation in place.  Even between online brokers, the price to trade shares varies quite a bit.  The least expensive trades at a Canadian online broker I’m currently aware of is Questrade who has $4.95 trades (actually $0.01 per share with a $4.95 minimum and $9.95 maximum charge).  If anyone else knows other good deals, please share in the comments.

As I stated in my “Putting your Finances on Cruise Control” post, stocks are considered risky because their values can fluctuate widely in a short period of time.  A way to reduce this risk is owning a number of stocks among a number of diverse sectors (like banking/finance, pharmaceutical, natural resources, technology, etc).  The theory is, the more “diversified” your portfolio is, the more protected you are from day to day fluctuations of any one stock.

It could be at worst quite difficult, and at best time consuming trying to personally identify a number of individual stocks across multiple sectors that you want to hold.  Because of this, many people who want equity in their portfolio hold stocks indirectly in the form of Equity Mutual Funds.  A mutual fund is merely a collection of securities that are administered by financial professionals who decide what securities to hold, and how much of them to hold.  Then “units” of the fund are sold to investors.  An Equity Mutual Fund is comprised of mostly stocks, and likely some cash on hand to make future purchases. (As opposed to a Bond Fund which would hold bonds, or a Money Market Fund which usually holds treasury notes.)

Mutual funds can simplify the ownership of stocks, but it can also come an increased cost: of course the fund managers charge a fee for their services.

More tomorrow about mutual funds, their fees, and some alternatives.

Every day in the news we hear about the day’s stock market results, but while stocks are often talked about I don’t think they’re widely understood.  There are many intricacies to stocks and I’m certainly not an expert yet, but this post is a quick primer.

Essentially a stock is a portion of ownership of the company who issues it.  Super-simplified example: If a company has issued 10 stocks, and you own 1: you own 10% of that company.

Companies issue stocks to raise money for various reasons (R&D for new products, hiring more employees for expansion, building a new factory, etc.).  Say company X’s stock is currently trading at $10, and they want to raise $10M, then they will issue 1M new shares for the public to purchase.

People buy stocks to have a claim on the issuing company’s future earnings or assets.  Say you think company X’s new product will be the next big thing, you might want to buy their stock for a piece of the earnings.

The price of a stock is determined by the perceived value of all future earnings of a company discounted (taking into account inflation, and risk) to today’s dollars.  In other words, if a company’s future earnings are perceived to be high with little risk, then the stock price will be high.  Alternatively, if the perceived risk that a company will go bankrupt is high (little to no future earnings), then the stock’s price will be low.  (Note that I keep using the word “perceived”.  It’s when perception differs from reality that stocks are mis-priced: either too high or too low.)

Now a bit of stock terminology:

• Price – this is fairly self explanatory: it is the current price that the stock is being sold for on a stock exchange.
• Number of shares – this is the total number of share that have been currently been issued by a company. (Sometimes a company will issue more shares as in the example above, but other times they will “buy-back” stock that they have issued with cash they have on the balance sheet.)
• Market Capitalization – most commonly abbreviated to Market Cap.  This is a dollar value calculated by multiplying the price of the stock by the number of shares issued.  (Ex. As I write this, Google has issued 316.57M shares and the stock is priced at $462.10, giving it a market capitalization of $146.29B)  This is the most common metric for the value of a company.
• Price/Earnings Ratio – abbreviated P/E: this is the ratio of the price of one share divided by the earnings (net profit or the company) per share.  A high PE indicates that investors are willing to pay more for the future earnings of that company (demand for the stock is high).
• Dividend – many (though not all) stocks pay out a portion of their earnings to shareholders: this payout is called the dividend.  Earnings not paid out in a dividend are re-invested into the company.  (i.e. Companies who do not pay a dividend re-invest all their earnings in the company.)
• Dividend yield – this is a percentage calculated by dividing the dividend per share by the price per share.  Say a share price is $20, and the dividend paid out is $1: this gives a dividend yield of $1/$20 = 5%.

I’m sure some readers are already very familiar with these concepts and terms, but for those who aren’t: hopefully I’ve explained a few of the basics and I’ll be building on them in future posts.