Stock

Stock (also known as 'equity' or 'share') is, quite simply, a slice of ownership in a publicly-traded company. When you buy a stock, you aren't just buying a digital blip on a screen; you're becoming a part-owner of a real business. Imagine a company is a whole pizza; a share of stock is one slice. As an owner, you have a claim on the company's assets and, more importantly, its future earnings. This is the fundamental building block for most investment portfolios and the primary vehicle through which value investing is practiced. It represents the difference between being a speculator betting on price wiggles and being a business partner investing in the long-term success of an enterprise. This shift in mindset is the first step toward becoming a successful investor.

Just like ice cream, stock comes in different flavors, each with its own characteristics. The two main types you'll encounter are common and preferred.

This is the type most people mean when they talk about “buying stocks.” As the name suggests, it's the most common. Ownership of common stock typically grants you voting rights, giving you a tiny say in how the company is run, such as electing the board of directors. Think of it as your shareholder democracy in action. The real prize, however, is the potential for growth. If the business does well, the value of your share can increase (called capital appreciation), and the company might share its profits with you in the form of dividends. The catch? It's all potential, not a promise. And if the company goes belly-up, common stockholders are the last in line to get paid, if there's anything left at all.

Preferred stock is a bit of a hybrid, sitting somewhere between a stock and a bond. Its main attraction is a fixed, regular dividend payment that the company must pay to preferred stockholders before any dividends are paid to common stockholders. This makes it a more predictable source of income. In the unfortunate event of a liquidation, preferred shareholders also get their money back before common shareholders. The trade-off for this “preferred” treatment is that you typically give up voting rights and the explosive growth potential that comes with common stock. It offers more safety than common stock but less than a bond.

Buying a stock isn't a lottery ticket; it's a long-term partnership with a business. For a value investor, the “why” is everything.

Legendary investor Warren Buffett describes compounding as a “snowball of money” that grows as it rolls downhill. Owning a piece of a profitable business is the ultimate snowball. As the company reinvests its earnings back into the business to grow, or pays you dividends which you can then reinvest, your initial investment can grow exponentially over time. It's the patient investor's secret weapon for building wealth.

A stock's market price constantly dances around, but a value investor focuses on what's solid and real underneath: the business itself. The goal is to determine a company's intrinsic value—what it's actually worth based on its assets, earnings power, and future prospects. You then aim to buy the stock at a significant discount to this value. This discount is your margin of safety, a concept championed by Benjamin Graham, the father of value investing. It's the cushion that protects you from bad luck or errors in judgment. You're not buying a ticker; you're buying a dollar's worth of business for fifty cents.

While the rewards can be great, stocks are not a one-way ticket to riches. Understanding the risks is crucial.

In the short term, the stock market can be a wild and emotional place. Benjamin Graham personified this volatility as Mr. Market, your manic-depressive business partner who, on any given day, might offer to buy your shares at a ridiculously high price or sell you his at a despairingly low one. A value investor learns to ignore Mr. Market's mood swings and use his pessimism to their advantage by buying when prices are low.

This is the risk that the company you've invested in simply performs poorly. Fierce competition, incompetent management, or a revolutionary new technology could cripple its profits. If the business fails, your ownership stake—your stock—could become completely worthless. This is why thorough research into the business itself is non-negotiable.

Over the long haul, stocks of great companies have proven to be a fantastic defense against inflation. However, periods of high inflation can be painful. It can increase a company's costs, squeeze its profit margins, and erode the real purchasing power of your investment returns.