Ep 3: What is a Stock?

In this episode, we dive into the basics of investing in the stock market with a focus on stocks. We'll cover what a stock is, how stocks generate profits, and important financial metrics like earnings per share (EPS) and profit margin. Understanding these key takeaways is essential for any investor looking to make informed decisions in the stock market. So whether you're a seasoned pro or just starting out, tune in to learn more about this exciting and dynamic world.

Episode Equity

What is a Stock and How Do Stocks Work? 

At its core, a stock represents ownership in a publicly traded company. When you own a stock, you own a small piece of the company and are entitled to a portion of its profits and assets. But how does this work, exactly?

Owning a Piece of the Pie: The Basics of Stock Ownership

Let's dive into what a stock is and how it works. A stock represents ownership in a publicly traded company, allowing investors to participate in the company's growth and share in its profits and assets. When a company wants to raise capital to expand or for their next endeavor, it goes through an Initial Public Offering (IPO) on the primary market, where it becomes a publicly traded company. After the IPO, the stocks are bought and sold on the secondary market, also known as the stock market, through brokerage firms. However, investing in stocks carries risk, as the value of a stock can decrease if the company is not profitable.

When a company decides to become publicly traded, it is listed on a primary stock exchange such as the NYSE or Nasdaq. This listing allows the company to raise capital by selling stocks to the public. In exchange for being publicly traded, the company is required to provide transparency to its shareholders by regularly sharing its financial statements. Once the company is listed, its stocks can be bought and sold on a variety of stock exchanges. This makes it easier for investors to buy and sell the company's stock and participate in its growth and profitability.

From Products to Profits: How Stocks Benefit from Company Growth

When a company sells its products or services, it generates revenue. But how does this translate to profits for stockholders? Here's how it works.

When a company sells its products or services, it generates revenue. Often, companies can generate revenue from different types of products and services. However, there are costs associated with running a business that must be accounted for called operating expenses. This is the money that the company has left over to pay for things like salaries, rent, and other expenses.  After subtracting the operating expenses/costs of producing and selling those products or services, the remaining amount is called operating income. The more operating income a company generates, the more money it produces to grow and invest in its business, which can lead to higher profits and a higher value for its stock. If a company’s costs exceed revenues, then they will be operating at a loss which generally has a negative effect on the value of the stock if costs continue to exceed revenue.

When a company or stock is generating a profit, investors expect the profit to be reinvested into the growth of the company contributed to a higher promise of value or redistributed to shareholders in the form of a dividend.

"When you own a stock, you own a small piece of a company and profit when the company goes up in value – when there are more sales, or less expenses than expected. This is how the stock goes up in price, the company is literally more valuable."

Making Sense of Earnings Reports: How They Impact Stock Value

Earnings reports are a crucial aspect of investing in stocks. They provide information about a company's financial health, including revenue, expenses, and profit. But how do they impact the value of a stock?

A company reports its earnings on a regular basis, usually quarterly. When a company reports its earnings, it provides financial statements and information about its revenue, expenses, and profit which represents the company's activity from the previous quarter. Analysts provide consensus on the earnings estimates, and the stock adjusts in value based on whether the company meets or misses these expectations. The stock price can also adjust based on the forward guidance provided by the company.

Forward guidance is an estimate of what can be expected in the next quarter inclusive of earnings and revenue. This forward guidance can have a significant impact on the stock, as analysts will adjust their future expectations based on the information and commentary provided on what the future holds for the company. Investors use this information to assess the company's future value and make investment decisions.

The Power of EPS: How It Reflects a Company's Profitability

Earnings per share (EPS) is a measure of a company's profitability that considers the number of outstanding shares of stock. But why is it important, and what does it reflect about a company's financial health?

Earnings per share (EPS) is a measure of a company's profitability that considers the number of outstanding shares of stock. EPS is calculated by dividing the company's net income by the number of outstanding shares of stock. This provides investors with a way to compare the profitability of different companies, even if they have different numbers of shares outstanding.

Earnings per share (EPS) can either increase or decrease over time. When a company's EPS is increasing, it means that the company is becoming more profitable, as it is generating more profit for each outstanding share of stock. This is generally seen as a positive sign for investors, as it indicates that the company is performing well and has the potential for future growth. On the other hand, when a company's EPS is decreasing, it means that the company is becoming less profitable. If a company's EPS is decreasing, it can be a sign that the company is facing financial challenges or that its profits are declining. This can be a cause for concern for investors, as it may indicate that the company is not performing as well as it has in the past.

Beyond the Bottom Line: Understanding Profit Margins

Profit margin is another important metric for investors to consider. It measures a company's profitability by dividing its net income by its revenue. But what does this really mean, and why does it matter for investors?

Profit margin is a financial ratio that measures a company's profitability. It is calculated by dividing the company's net income by its revenue. The result is expressed as a percentage and represents the amount of each sales dollar that is retained as profit. Profit margin is an important metric for investors, as it provides insight into a company's ability to generate profits from its sales. A company with a high profit margin is generally considered to be more profitable than a company with a low profit margin, as it is able to retain a larger portion of each sales dollar as profit.

Profit margins can come under pressure when expenses increase or sales decrease. If a company's profit margins are decreasing, it can be a sign that the company is facing financial challenges. On the other hand, if a company's profit margins are increasing, it typically indicates that the company is generating more revenue or reducing its expenses, which is a positive sign of its financial health. This is often attributed to effective management practices.

What did we learn? 

  1. A stock is a type of investment that gives you a share of ownership in a company.
  2. A company's profitability can be measured through earnings per share (EPS) and profit margin.
  3. A company reports its earnings quarterly, it provides information about its past quarter performance and future quarter expectations, which can impact the value of its stock.
  4. It is good to see increasing EPS and revenue, expanding profit margins, and optimistic forward looking guidance

Jessie's Questions

  • Q: What is a stock?
  • A stock is a piece of a company that represents fractional ownership.
  • Q: Why do people want to buy stocks?
  • People buy stocks to put their money to work and participate in capital appreciation.
  • Q: Why does a company sell stocks and how does a stock become public?
  • Companies sell stocks through an initial public offering (IPO) to raise capital and become publicly traded. Going public involves meeting regulatory requirements and being listed on stock exchanges like NYSE or NASDAQ.
  • Q: What is the Securities Exchange Commission (SEC)?
  • The SEC is a regulatory body that oversees and regulates securities trading to protect investors' interests.
  • Q: Why do people buy penny stocks?
  • People may buy penny stocks due to the promise of potential value or for the adrenaline rush. Penny stocks can be more accessible in terms of price, but they also carry higher risks. Hence they are an easy target for scammers. They also have less regulatory requirements and oversight.
  • Q: How does a stock make money?
  • Stocks make money through revenue streams that exceed costs, resulting in operating income. Increased sales and efficient management contribute to higher profits and stock value.
  • Q: What are the different types of stocks?
  • Growth stocks: Companies reinvest profits to expand and increase stock value.
  • Income stocks: Companies distribute profits as dividends to shareholders.
  • Value stocks: Stocks of companies with lower prices but still listed.
  • Blue Chip stocks: Stocks of large, well-established companies.
  • Q: How do we know if a stock is making money?
  • Companies report earnings quarterly, providing information on past performance.
  • Analysts provide earnings consensus and forward-looking guidance for future performance.

Episode Transcript

Jess: Hello, fabulous future financiers. Welcome to the Market MakeHer Podcast.

Jessie: This is your safe space, your financial empowerment zone. I'm your host, Jessi DeNuiet, here to ask the hard questions, making things simple, fun, and relatable.

Jess: And I'm Jess Inskip, your resident finance expert with almost 15 years of experience here to provide. all of the answers.

Jessie: And we're on a mission to break the money barriers and decode the jargon that's been keeping you from conquering the stock market. So let's dive into today's episode.

Jess: And today we're going to break down what exactly a stock is, how it works, and how stocks make money so you can potentially make money too. But before we dive in, we'd like to remind you to also check out the episode equity that comes with every episode on our website, which is Market MakeHer, H-E-R podcast.com that's MarketMakeHerPodcast.com. Resources, infographics, extra explanations. We break down today's topic even further and answer all of Jessie's questions.

Jessie: Yes, and I have a lot of questions as usual. So today's episode is, what is a stock? Which means my first question for you, Jess, is, what is a stock?

Jess: So a stock in its simplest form is a piece of a company. It represents... a small fractional ownership in some type of corporation or bigger company of some sort. So when you own a stock, you effectively have equity or ownership of that company, which means that if they make money, you potentially could make money as well.

Jessie: So you're literally just buying a piece of a company.

Jess: That's right.

Jessie: So, Why do people want to buy stocks?

Jess: So you buy stocks to put your money to work. So there are lots of different asset classes within the stock market overall, one of which is stocks. So a company will issue some of their stock, which represents ownership like we established. And the reason you would buy into that is because you want to make, have your funds participate in capital appreciation, which just simply means as that company makes money, since you have a partial or fractional ownership of that company as well. You make money too.

Jessie: Yeah, I wanna make my money make money.

Jess: That's right.

Jessie: Okay, so a stock is just owning a piece of a company. And when you buy a piece of that company, or maybe multiple pieces of that company, you are hoping that the company does well so that your money that you put into the company makes you more money back basically.

Jess: Yeah, as that company grows and gets bigger, then the value of your stock ownership or fractional ownership will get bigger as well. And that's how your money grows and why you would invest in a stock because you would make money literally as that company makes money.

Jessie: Why does the company sell stocks and how does the stock become public? I always hear about stocks going public. How does that process work?

Jess: The definition or the term is called an IPO, which is an initial public offering. And this actually happens at the advanced stages of a company's life. A company when it first starts up. You might hear of like venture capitalist where they invest all these assets to a startup company of some sort. When you decide to go public, which means now you're going to be traded on the secondary market, which means you're going to have a responsibility to shareholders, which are you and I, the people who want to buy the securities. You also... are going to be regulated by the Securities Exchange Commission and the SEC. So that's why I say it's a really advanced process for a company. And they do that when they grow up, because they can handle that responsibility that is additional regulation and shareholder representation. The process of going public or that initial public offering, what happens in that graduation aspect is those angel investors or VC, they kind of cash out at that point. We put in all of our money, you're going to go public. They issue stock. Now they're selling a piece of that company that they grew and they built. And they're going to get another influx of cash, but no longer from VC or angel investors at that point, mainly.

Jessie: Can you talk about that SECC thing again? It's the, what is that?

Jess: The Securities Exchange Commission. There is so much regulation within the finance industry that we have established so far. Right. There's another one, the SEC, and they regulate securities that are traded. But this is good and it's for our benefit. So those private companies, you can't just come in and say, hey. Let me look at your balance sheets as in how much profit are you making? Where are your revenues? What are your sales? What are your expenses? You can't do that. But when they go public, they're literally offering a piece of fractional ownership of their company, you have the right as a shareholder to see that type of information. So that regulation, if you decide when you become listed is what we call it, is what you are confined to. So as the shareholder, you need to know if they're going to make money. And in order to know if they're going to make money, you have to have access to these set of documents really.

Jessie: Okay. Well, this is good to know because admittedly, I have bought stocks in companies and I don't look at any of that stuff. Okay. Not just any company, any small company, any company at all can just like be like, okay, who wants to buy some stocks in the company? You have to go through this process. It's heavily regulated, which is for our benefit. And once this company goes public and has the initial public offering or IPO, that's when we can, like the public, go and buy pieces of that company or stocks, right?

Jess: That's right. And what happens is they become listed on a stock exchange of some sort. So the New York Stock Exchange or the NASDAQ, those are two really popular exchanges that would list your security that make it accessible and tradable. There's also something called trading over the counter, which is where your penny stocks are found. They do not have that heavy, heavy oversight, which means there isn't as much transparency into those balance sheets and the documents and the regulation that's required to know if they're making money. And that's why that's where sometimes a lot of scams can happen. because of the tech market.

Jessie: Wow, good to know. I knew that penny stocks were not the best investment, but I didn't realize that was why.

Jess: It makes sense, because if you're going to buy a piece of a company and the intent is for you to participate in profits when they make money, we need to know how that's happening.

Jessie: But with penny stocks, that's not really regulated like that.

Jess: It still has requirements, not as stringent requirements. Total tangent and side line, but you can go to the OTC website and there are penny stocks that are called caveat emptar. They literally have a skull and crossbones on it and it means do not buy. They have not given us their quarterly statements that they're required to.

Jessie: Okay. That just makes me want to ask why do people even buy penny stock that doesn't know this.

Jess: People buy penny stocks. It's either A, for this promise of value that isn't understood B, it's an adrenaline rush. Penny stocks are not for pennies. Actually, the definition is under $5 a share. So they're cheaper. And in their cheaper stocks, they seem more accessible. And then there's the psychological aspect that if I'm buying a cheaper stock, I can make more money because I'm putting less capital, which isn't necessarily true. But now with technology, we have fractional shares and other ways that you can put. a little more money and a better investment.

Jessie: Yeah, I did know about that. And I think probably when I was a little younger, I know I bought some penny stocks, probably with the same kind of thought process, thinking like, oh, these are gonna make me way more money with not as much money to put into it. But now with fractional shares, you can just buy, you know, with a little bit, if you don't have as much money to get started, which was always a thing that stopped me when I was younger from investing. I felt like, oh, I have to save up $10,000 before I can I. I can even invest in anything and now that's just not true. You can start with as little as what, like $5.

Jess: Exactly. Another barrier to entry brought down.

Jessie: Okay. Well, let's talk about how our money can make money. How does a stock make money?

Jess: So stocks, since it's a piece of a company, it has different revenue streams. They make money as long as revenues exceed costs. We call that operating income.

Jessie: OK.

Jess: I'd love to give you a real example with Apple.

Jessie: Yeah, let's do it.

Jess: Revenue just means the sales that they make. Apple sells iPhones. That makes up half of their revenue. They also sell services. That makes up 20%. They've got wearables, so AirPods, things like that. The Mac computer, the iPad used to be iPod, if you remember that. But in order to make an iPhone or provide those services or have AirPods or... have that really cool modern Apple store, they have operating expenses. That's their brick and mortar, the parts that it costs to make an iPhone, how much they pay their employees, all of that put together, does the revenue exceed how much the expenses cost?

Jessie: And if they're making money, then we're making money.

Jess: Yes, then that should be reflected on the stock.

Jessie: Can't a company maybe not be profiting and their stock price goes up?

Jess: Yes. that's super important to know. The stock market is always forward-looking, meaning it's the expectation of future value. You could have a company that has something happen where you expect revenue to increase or you expect cost to decrease. The stock's gonna immediately react because that's a promise of value. We described one thing and we didn't give it its name and that's a... profit margin. The profit margin is just the difference between revenue and costs. For a company to go up in value, they need that to expand and get wider, which just simply means, are my costs going down and is my revenue going up? Or a combination of some sort. Costs going down can be layoffs because you implemented AI. Now you might have had a big upfront expense, but your future expense is much, much lower because you don't have to pay all this headcount.

Jessie: I guess this is how the stock market can fluctuate so much because you can say the company is profiting more because they laid people off. Well, now we have more layoffs, so people are spending less money, and eventually that's going to affect the performance of the stock as well, won't it?

Jess: It absolutely does. And that's where it's all related. It's unfortunately not that black and white, but it is that simple and exactly the way you're thinking about it. You want to know where people are spending money. That's the revenue side. And then cost is management and efficiencies. And that's why we look at profit margin that range in between revenue and cost. A small profit margin means that if I've got, in simplistic terms, a hundred dollars of revenue and $99 worth of expenses. Well, if I don't make as many sales as I normally do, I'm going to be negative. net profit really, really quickly. But if I have $100 of revenue, but $25 worth of expenses, that's a 75% profit margin. I can handle less sales because I don't have as high a cost.

Jessie: Right. That makes sense.

Jess: And that goes with management. It's like how you manage your money. Do you have a savings account? Do you have an emergency fund? How big is the company's emergency fund?

Jessie: That makes sense. So it's basically like not only... how the company is profiting, but just like kind of how they're structured, does well, has products that people like to buy, but they also know how to manage their company.

Jess: That's absolutely right. It's three main components that you look at. How much money are they making? How much does it cost them to make that money? What's their management structure look like?

Jessie: Okay, so we know how a stock makes money. Do we need to talk about different types of stocks that there are?

Jess: Yeah, back to that. Extreme example of $100 worth of revenue, $25 worth of expenses. That means $75 worth of profit, which by the way, that's super amazing profit margin unheard of. That $75 of profit is going to be distributed to you, the shareholder, in one of two ways, mainly. First is in a growth stock, which means they're going to take that money that they made, they're going to put it back into the company, invest in new technology so they can generate more sales. When they generate more sales or the promise of more sales because the market's forward-looking, the stock goes up in price. Or B, they take a piece of that and they distribute it to you as a dividend. And that's an income type of stock. So growth and income. And stocks can be a combination. And oftentimes, they are.

Jessie: Is that like outlined somewhere when you buy a stock, what kind of stock it is? Or do you just have to understand how to figure it out?

Jess: You can always just see their dividend yield and you can see how much that is. And then that will tell you if it's an income stock or not.

Jessie: You get a little bit of money back every quarter, right?

Jess: Or however they issue it. It's up to them normally quarterly.

Jessie: Would you say growth stock is the most common?

Jess: Mainly like tech stocks.

Jessie: What other kind of stocks are there?

Jess: Value stocks. That's where they're. prices lower, but they're still listed, so they're not a penny stock. But those tend to be smaller companies. Blue chip stocks, if you've ever heard that term.

Jessie: Nope.

Jess: Those are your super big, been there forever type of companies. Pepsi comes to mind immediately, or Coca-Cola, as blue chip stocks because they've just been around forever.

Jessie: So we have growth stocks, which are usually in the tech space, maybe not always. Dividends, which is just any company that gives the stockholders a little bit of money back. Value stocks, which are not penny stocks, penny stocks, which we know are risky. And then the blue chip stocks are the ones that are just, the companies that have been around forever.

Jess: That's right. So many different types of stocks and we've scratched the surface. Y

Jessie: es. So now we know about different types of stocks. How do we know if a stock is making money?

Jess: The earning season comes quarterly. One of my favorite seasons in addition to spring wear. When a company goes public, now all of a sudden there's transparency. We know how that company is making money. However, if you ever looked at a balance sheet or cash flow statements, income statements, that is a ton to go through and nobody wants to do that. And you don't have to. There are analysts that cover a lot of stocks. And sometimes you'll have a hundred analysts cover one stock if it's a really big stock. They provide a earnings consensus. And they say, based on our discount cashflow model or whatever model that they're running that you do not have to do because they do it, and this is self-directed investing and there are a lot of resources out there, they will say, this is how much earnings we expect this company to make per share. The company reports on that number quarterly. So it's this big event. They tell us if they beat or miss expectations. First, it starts with it crossing the wire, and then you can see the stock move immediately. But we want to get into the why. There's something called forward-looking guidance that's optional. Companies do not have to give that. Apple, for example, we always use them as our example. Say they have their earnings, and they meet expectations. Expected to have earnings of $3 per share, and then they reported they have earnings of $3 per share, but forward-looking guidance. hey, we opened this store in India, which they did do, and all of a sudden we're seeing a lot of sales that are there, so we expect that to translate positively into our next quarter's earnings report, and then that will make the stock go up. So an earnings report happens quarterly, and it's a number that they are expected to hit or miss, hopefully be in line with expectations, and it's a measurement of the past three months. past quarter. And then forward-looking guidance is expectations for the next quarter. And that's important to know as we go forward because the market looks at everything quarterly.

Jessie: Is each earnings season, it's quarterly, right? So is that earnings report or like, is it the same for every company? Like it's the same day for everybody?

Jess: The bulk of it tends to be in a two-week period, but it's normally a four to five-week period. And then also your brokerage firm has. literally all of this information.

Jessie: That's what I was going to ask. Sounds like a lot.

Jess: Yeah. Analysts also rate stocks, and they will say, buy, sell, hold, something like that, and give you a price target. So they do all of that work for you, so you don't have to go through that. You just need to look at analyst opinions.

Jessie: So when you see on whichever brokerage firm or app or whatever you're using, and you're looking at stocks or ETFs or whatever you're looking at, potentially to buy. I've seen the buy sell analyst ratings, which now I'm realizing I'm connecting the dots. So those are the analyst ratings that people who do this for a living basically hold the stock or buy the stock or sell the stock, right?

Jess: Yeah, it's just how your brokerage firm displays it. Some compile them together, some come up with their own proprietary score, some list them out. but usually it's all of the same providers. And that goes back to our very first episode when we were talking about the way that brokerage firms attract you is by the features that they offer you. And one of those features is analyst ratings and ways to look at stocks being profitable.

Jessie: Okay, cool. This is all great stuff to know and consider as we go forward, understand what we need to know and how we can just like come up with good strategies for ourselves as self-directed investors.

Jess: Yeah, the important. takeaway from this episode was just understanding that a stock represents a fractional ownership of a piece of company. And when you are investing in that company, you expect them to make more money or their revenue to go up. Because when that happens, you're going to participate in that revenue. We call that capital appreciation. That's in the form of them reinvesting it back into the stock to make even more money for your money, or you're going to get a dividend, so some income or a combination there of.

Jessie: Well, that makes it simple. I like it. Let's cover what we learned today. We learned what a stock is. So as we said, a type of investment that gives you a share of ownership in a company. You got a piece of that company, maybe a few pieces, depending on how many stocks you buy. How we know a stock is making money. A company reports its earnings quarterly and provides information about... past quarter, if it like, basically every company like sets their goals each quarter and did they meet those goals, exceed them or fall short? And that can influence the price or the value of the stock. Yes, goal setting, did they make or break the goal? When we're looking at the performance of a stock, we want to see an increase in that EPS and revenue. How the company's performing, are they doing better than they were before? Because that's going to drive the value of their stock.

Jess: So, Jessie, we had a question on our TikTok.

Jessie: Let's see, Clarissa wrote in, how do you actually choose what stocks to trade? What strategies are there?

Jess: So we talked about the different type of stocks and that will go into your strategies from a stock perspective. So are you buying the stock to participate in capital appreciation, which is usually the case, you want your money to go up in value. But do you also want an income from that type of security or that investment that you're making? That actually requires a lot more depth where we're going to have a whole episode actually dedicated to you, Clarissa, where we'll talk about portfolio management. Because then that's when you decide not only the type of stocks that are right for you, but how to manage those. Because entry and exit and growing your wealth over time is also really important.

Jessie: Yes. That's a great question. And I have more questions around that one too. So can't wait to get into that one. Thank you for the question, Clarissa.

Jess: Thanks Clarissa.

Jessie: I think that's a good wrap for today's episode. And I hope the audience has found it as enlightening as I did. But remember, the conversation doesn't stop here.

Jess: And if you found our conversation helpful, don't keep it to yourself. Please spread the word. We're setting the table with these first episodes. But we're really going to get into that deep information. So share our podcast with your friends. rate us, leave a comment, your feedback fuels our mission. We really wanna address your questions.

Jessie: And most importantly, we hope you feel a bit more financially empowered today and that you will continue to be more empowered as we continue learning about the stock market together. So don't forget to subscribe and stay tuned for more enlightening episodes. And remember when you build knowledge, you break barriers.

Jess: And before we sign off, remember to visit our website, marketmakeHerpodcast.com That's MarketMakeHer, H-E-R, Podcast.com for the episode, Equity. Our deep dive into today's topic and the answers to Jesse's questions. We're here to make finance easy for you, one episode at a time. Until next time, keep investing, keep learning, and keep breaking those barriers.

[Disclosure] There is always potential to lose money when investing in securities. Market Maker provides educational content and resources for informational purposes only. We are not registered financial advisors and do not provide personalized investment advice. Any information provided by Market Maker on our website or podcast is not intended to be a substitute for professional financial advice. Market Maker is not liable for any investment decisions made based on our content. For more information, visit markmakeherpodcast.com