Investing in stocks implies that you first buy the stock of a company. A stock represents the ownership of a company. Ownership of stock has several benefits over other investments, whether in fixed deposits or other securities.
As a stockholder you can exercise the right to participate in major decision-making processes of the company. Every share represents a vote. So the larger the number of shares you have, the larger influence you can wield in shaping the policies of the company. If the company makes profit, your share of profits will depend upon the number of shares you own.
Though most people buy shares only to sell them off when their prices appreciate, there are investors who have long-term perspective. Such investors earn the periodic profits that the company makes.
Companies often announce dividends in form of bonus shares, which may be in the ratio of 2:5 or even 1:1 ratio. For example, if you own 100 shares of a stock, you may get 40 shares free of cost taking your ownership to 140. In case of 1:1 ratio, your holding may increase to 200 shares.
Of course, the value of the share also falls when the bonus shares are allotted, but the share prices rise again over the course of time and your earnings naturally increase.
Imagine starting with just 100 shares of a truly good company when you are young and their total value when you retire after 30-40 years. They not only grow in number, but in value as well. It has a multiplier effect. Your initial stock of 100 shares may grow to 200, say, in first 5 years and 400 in the next 5 years and so on. Depending upon the value of your share, you may end up being a millionaire when you retire.
Besides rewarding the customers with extra bonus shares, some companies distribute profits in form of dividends. The dividends are issued once or twice a year depending upon the earnings of the company and the discretion of the company directors.
If you instruct your stock broker to reinvest your dividends in dividend reinvestment plans, also called DRIPs, your earnings multiply at compounded rates. Initially, your dividend may appear rather insignificant. But, if you just sleep over them, you will be surprised how much you have accumulated over a decade. You will be amazed at the fortune you may have made. Each dividend earns dividend upon itself and the process continues. Your earnings multiply at geometrical progression. Such is the power of compounding.
What matters is that when you invest, you should instruct your broker to reinvest your dividends and just forget thereafter.
While there are advantages of investing in stocks, it should not be forgotten, that the reverse could also become true. If the company that you invest in fares badly, your investment, instead of appreciating, may lose its original value and you may come to loss.
How do you ensure that the company whose stock you invest in has strong financial foundations and promises good future?
The first important step in this direction is to study the financials of the company. You should study its quarterly, half yearly and annual balance sheets, its future investment plans, the orders, the total market value of its stock, the profiles of the company directors, its performance since its inception and so on.
The stock market itself is a reliable indicator of the actual value of the company that issues the stock. The value of a company's stock at a given time depends up the financial data, which includes the sales figures, assets and growth rate of the company. There is no doubt that these factors also keep changing. But, by and large, there is an element of constancy in the performance of the company.
Well-administered companies usually continue to grow and provide dividends to their shareholders.
After having decided which company has strong financials, you must wait patiently for the time when the price of its stock falls, which is bound to occur is given the uncertain nature of the stock market.
The present recession is the best opportunity to invest. The prices of the stocks of good companies has fallen as much as 40-50%.
The situation is bound to change for the better over time, given the nature of the stock market. Those who are not swayed by the warnings of the doomsday pundits, can jump into the stock market arena and reap the benefits once the tide changes in future.
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