What are stocks? How do Stocks Work? Why do Investors Buy Them?

How do stocks work?

An organization issues the stock to the general public through Initial Public Offering (IPO). An IPO is the process of offering the shares of an organization to retail investors and institutional investors.

After going through the IPO, the shares of the organization would be traded on the stock exchange like New York Stock Exchange or NASDAQ. The shares are transferred from one investor to another on stock exchanges. The Securities and Exchange Commission (SEC) regulates these transactions to protect investors from fraud.

Why do companies issue stocks?

Companies issue stocks when they plan to raise funds for business expansion. Companies have two options to finance the business expansion.

Debt financing is a process of borrowing money from a financial institution or another eligible third party at a mutually agreed interest rate. The organization should repay the interest and principal amount as per the agreed timeframe. Equity financing is the process of issuing shares of the organization to raise funds. Organizations prefer equity financing because it does not carry any repayment obligation. Equity financing enables the organization to utilize funds on strategic initiatives without feeling the burden of repayment.

Companies also issue equity to maintain a suitable debt-to-equity ratio. Issuing stocks ensure that the company does not borrow more money than prescribed. The huge debt makes the company less attractive for lenders in the future. So, organizations issue stocks to maintain financial stability and improve future borrowing ability.

Issuing stock to the public is an important element in the lifecycle of any company. The public limited companies gain huge traction in the market, both in terms of publicity and credibility. Though this benefit is intangible, it helps the organization attract big customers and improve profitability.

Main Types of Stocks

Stocks can be classified into several types based on various characteristics like market capitalization, dividend-paying history, and revenue growth prospects.

Common vs. Preferred Stocks

Common stocks are ordinary shares issued to the general public and owners of the company. Common shares can be purchased and sold on the stock exchange. Common shares give the right to vote on major corporate decisions.

Preferred stocks are also called preference shares. Preferred stock is a class of stock that gets preference at the time of liquidation. The preferred stockholders receive dividends before the common stockholders. However, they are not entitled to vote in shareholder’s meetings. Risk-averse investors often choose preferred stocks.

Penny Stocks

Penny stocks are the common shares of small-scale public companies that trade below $1 per share. The penny stocks are traded over-the-counter rather than on the trading floor. Penny stocks are highly volatile due to a lack of market liquidity. Penny stockholders often find it very difficult to cash out their positions due to the non-availability of buyers.

Growth Stocks

Growth stocks are the stocks of companies that have the potential to exceed expectations in cash flow, revenues, and market share. These companies would grow at a much faster rate than an average company within the same industry.

Dividend Stocks

Divided stocks are the stocks of companies that pay consistent dividends to shareholders. These companies generate good revenues every year and distribute a portion of profits to shareholders.

Some of the well-known dividend stocks in the United States in January 2023 are:

1

AT & T (NASDAQ: T) with a forward dividend yield of 7.64%

2

ExxonMobil (NYSE: XOM) with a forward dividend yield of 5.8%

3

Chevron Corporation (NYSE: CVX) with a forward dividend yield of 5.4%

Blue-chip Stocks

Blue-chip stocks are the stocks of large-scale organizations with high credibility and reputation in the market. These companies are the leaders in their respective industries. The best examples for blue-chip companies are Amazon (NASDAQ: AMZN), Microsoft Corporation (NASDAQ: MSFT), and The Procter & Gamble Company (NYSE: PG).

How much does Investing in Stocks Cost?

Several costs are associated with stock market investing or trading.

Let us take Webull, one of the well-known online trading platforms, as an example to identify costs.

Deposit and withdrawal fees

ACH Deposit and Withdrawal to any U.S. bank is free on Webull. However, deposits and withdrawals via wire transfer using any U.S. bank account attract a fee of $8 and $12 per transaction respectively. Deposits and withdrawals via wire transfer using a non-U.S. bank account attract a fee of $12.5 and $45 per transaction respectively.

Stock Transfer Fees

Stock transfer refers to the process of transferring stocks from one brokerage account to another. The fee for transferring stocks to Webull from another platform is zero. However, transferring stocks from Webull to another broker would cost around $75 per stock transfer to investors.

Postage Fees

The clearing corporations charge postage fees. As reported by Webull, investors should bear the following fees:

1

The Paper Confirm Fee of $2 per confirm

2

The Paper Statement Fee of $5 per statement

3

The Paper Prospectus fee of $2.5 per mail.