Why do companies issue stock? Why do investors buy stock?
Questions worth considering, because our motives can become very fuzzy if we ignore the basics.
Companies issue (sell) stock to raise capital. There are other ways to raise capital, but they all involve creating debt. When a company issues stock, they do not create debt. They have no legal obligation to repay those funds. So issuing stock is a very desirable way for companies to raise capital.
Investors buy stock for a variety of reasons, many that are not too logical. When you invest in stock, you ultimately expect to sell the stock at a profit. If the investment is sound, if the company has a solid business, if the company uses the funds wisely, you have a good chance of making the profit you expect. If not, its a risky game!
Do your research before investing!
I think it is prudent to invest in stocks that are solid performers and there are many choices. There are many excellent free research resources on the internet. Spend some time in the Research Section at our site: DRP Stock List
Price/Earnings (P/E) ratio. One of the classic measures of stock value, it is simply the stock Price divided by the annual Earnings per share. If the earnings increase, the price should go up. And investors look for companies whose earnings are likely to go up. Compare P/E ratios for several leading stocks within an industry to determine if a stock seems fairly priced.
If P/E is the only factor you consider, you will find that it eliminates many of the hot stocks of the day, e.g. most of the new internet issues. The reason is simple, the new internet issues typically have little if any earnings. So the P/E ratio is sky high. It takes spectacular earnings growth to catch up with the price to make the P/E ratio make any sense.
Dividends and what is stock yield? Let's take an example. If a company pays $2.00 dividends annually and the stock sells for $40.00, the yield is 5% ($2 divided by $40). Utility companies typically pay the best yields, growth companies pay out much lower yields. The logic is that growth companies reinvest the dividends to create more growth in the future, which should translate into
higher stock prices.
Researching and selecting stocks takes homework and time. If you expect to succeed long-term, face up to the task. Don't get caught up in the "hot stock of the day" trap. If the stock seems too good to be true, it probably is.
These ideas are just starters. Learn as much as you can about a stock before you invest. If you let greed rule your decisions, you are likely to get burned. And that won't feel good.
