Understanding Stocks for Beginners | Jessie's Notes

Jessie’s Notes On Stocks: What are they, why people buy them, how they make money.

In Episode 3, Jess Inskip taught us about stocks and how they work. She also provided an in-depth article about stocks in the Episode Equity of the Ep 3 page. I took the following notes and wanted to share them with you as a simple review for beginners on everything we learned about understanding stocks. I also included vocabulary words to help explain all the jargon! The “TL;DR” (too long; didn’t read) version is at the bottom. ;)

What is a stock in simple words?

A stock is simply a piece of a company that you can buy. It’s a type of investment that allows you to buy shares of ownership in a company (a fractional ownership). When you own a stock, you have equity (ownership) in that company, which means when they make money - you will hopefully also make money (by selling your stock or collecting dividends)! The company has to be publicly traded. 

How does a company get to sell stocks? How do they “go public?”

When a company first starts out, they might have angel investors or venture capitalists funding them. When the company decides to “go public” it means they have to go through a process and agree to have a responsibility to share-holders, which will be heavily regulated by the SEC. At this point, the initial investors cash out and might get issued shares of stock in the company. After the securities (stocks, bonds, etc.) are sold for the first time, those initial investors/buyers can go to the secondary market (i.e. the stock market) to “trade” or sell their initial investments (probably after the value goes up - it’s a supply and demand type of concept). 

When a company goes public, they have an IPO (initial public offering) and get listed on the stock market (with one of those ticker symbols), so that we can buy shares of stock on the “secondary market” (the "Plato’s Closet/Depop/Poshmark/Rebag" example from Episode 02). As a part owner of the company, you have a right to see the company's balance sheets, profits and losses, and even participate in voting.

Why do people buy stocks?

The basic idea is that you invest in a company you think is going to be successful by buying pieces of a company as stocks. You want to put your money to work! As this company makes money (since you now have a fractional ownership in this company), your funds can participate in capital appreciation - meaning you also make money (when you sell the stocks for a higher price and/or if the company gives you dividends). 

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As Liz Lemon on 30 Rock once said:

How many shares of stocks can a company sell?

Oof, I went down a rabbit hole with this one and sent Jess a bunch of voice messages going back and forth about it! Idk why I even asked! Basically, there’s a number of authorized shares at the beginning and it can be increased or decreased…

A company can issue only a certain amount of “shares outstanding” (let’s not even get into this definition yet, it’s going to have to be another Dividends article). You can take the Market Cap  and divide by share price and the result is the number of shares the market capitalization was based on. We’ll have to dive into it more later.

How do stocks make money?

Basically, a stock makes money when revenue exceeds operating costs of a company. A company has different revenue streams. For example, Apple has revenue/sales in iPhones, accessories, storage services, etc. They also have overhead for their brick and mortar stores, the cost of paying employees, cost of what it costs to make products - all of this put together is operating costs. Does the revenue exceed how much their expenses cost? If so, then the stock should do well and increase in value. This is why we look at profit margin in a company - it’s the difference between revenue and cost. It can tell us what the potential for future value.

The stock market is always “forward looking” meaning the expectation of future value. Is the cost going down and the revenue going up? That means the stock will go up because the profit margin is looking good. Say a company announces some new product that’s expected to be bought like crazy. That shows an optimistic forward looking guidance on how the stock is expected to perform in the near future. Things can always happen though (ahem, pandemic/layoffs/inflation) that might disrupt the value of stocks. The stock market fluctuates. Look at companies that have good management systems in place (like an emergency fund if a pandemic happens so they don’t go completely under). 

How do we make money on stocks we buy?

You either sell the stocks for more money than you bought them for and/or collect when the company gives you dividends (some money back when they profit). 

What are the different types of stocks?

• Growth stocks: Companies reinvest profits back into the company to expand and hopefully increase stock value. These are mainly like tech stocks.
• Income stocks: Companies distribute profits as dividends to shareholders (when you get that little bit of money back each quarter or whenever they want).
  
• Value stocks: Stocks of companies with lower prices, but still listed. Not penny stocks.
• Blue Chip stocks: Stocks of large, well-established companies (grand-daddy stocks like Coke and Pepsi).

Penny Stocks Are Risky! Why do people buy them?

Penny stocks are not heavily regulated by the SEC. They’re usually under $5 per share, and seem practical at first glance with the dream that you’re going to make a ton of money off of them. However, you can also easily lose that money. And now with fractional shares, you don’t have to have a lot of money to invest in the stock(s) you want. 

Earnings Season and Analyst Ratings

Good news! You don’t have to keep up with earnings season or know all of the profit models, margins, and the numbers for every company you own a piece of (stonks). Check out the “analyst ratings'' at whichever brokerage firm you are using. They all have some version of this. 

Vocabulary Words:

1. Stock - a piece of a publicly traded company you can own (by buying it)
2. Share - a single unit of a stock
3. Equity - ownership, you receive equity by buying stock
4. Shareholder -  us, the people buying these shares
5. Fractional Ownership - owning a piece of a company when you buy a stock or other security
6. Fractional Share - A piece of a share of a stock. This allows us to be able to buy an expensive stock with less money. So if a stock is worth $300 and you want to buy it, but don’t have that much money, you can buy a fractional share for, say, $50 instead. 
7. IPO -  initial public offering - happens at the advanced stages of a company’s life. The company goes through a regulatory process by the SEC and “goes public” in order to sell pieces of the company to the public for the first time.
8. SEC - securities and exchange commission (https://www.sec.gov/) - protects investors from market manipulation by regulating securities that are traded.
9. Ticker Symbol - letters that represent specific shares traded on the stock market (ex. Apple’s is AAPL)
10. Capital Appreciation - as a company grows and makes money, you also make money  (if you own stocks/equity in that company and either sell your stocks for more than you paid for them and/or if the company offers dividends).
11. Dividends - an amount of money paid regularly by a company to its shareholders out of its profits. 
12. EPS - earnings per share - it’s good to see increasing EPS and revenue when we’re looking at the performance of a stock.
13. Forward Looking Guidance - a publicly traded company’s predictions and goals for future business conditions. Basically, what impacts of current events are going to show up in their earnings. We want to see optimistic forward looking guidance from a company we bought stock in. Companies don’t have to disclose this. 
14. Earnings Report - measurement of past quarter/3 months showing a number the company was supposed to hit. Brokerage firms and analysts do all the work of going through all the reports, so you don’t have to. 
15. Profit Margin - costs going down and revenue going up
16. Penny Stocks - super risky; under $5 per share and were more popular before fractional shares came into play.

This is just the tip of ye olde iceberg. The more we talk about all these concepts the more it’s all going to come together. We’re going to make the stock market make more sense, one episode at a time! Tune in, learn, and (hopefully) earn with us! Check out Episode 3 in its entirety along with the Episode Equity article! 

TL;DR: What I learned about stocks on Episode 3

• A stock is a type of investment you can buy to own a “share” or piece of a publicly traded company. It’s just a piece of a company.
• When you buy a share you have a “fractional ownership” of that company. (Not to be confused with a “fractional share,” which is a piece of a share.)
• As an investor in the company, you expect to see an increase in EPS, revenue, profit margins, and optimistic “forward looking guidance” - so that you can make money off your stocks as the value of the stock increases.
• A company can only sell stocks once they go through the approval process with the SEC and have an IPO. 
• Earnings season happens quarterly and tells us how companies we’re invested in are performing.
• Companies report their earnings quarterly and whether or not they are making money directly affects how the stock performs (it goes up or down in value). It can also go up and down in value on a daily basis (not just quarterly when earnings are reported).
• There are different types of stocks: growth, income, value, blue chip
• Penny stocks are risky! They’re not as heavily regulated - and not really as appetizing when we can now buy a piece of a piece of a company (fractional share).
• Look at analysts ratings - these people have a job for a reason and do all the hard analysis work for you when deciding on trading stocks.