What are Stocks and How Stocks Work?

While stocks are the most profitable investment option in India today, the majority of the investors are still unaware of what are stocks, how stocks work, and how to make money in the stock market.  Today, we will discuss what are stocks, different types of stocks, the difference between stocks and shares, the difference between shares and bonds, and how you can make money in the stock market. In this article, we have explained What are Stocks? Why do companies issue stocks? Why do investors buy stocks? What is the stock market? What are the types of stocks? What are stocks and bonds? How do stocks work? So, let’s get started! 

What are Stocks? 

In simplest terms, Stocks are financial instruments representing ownership in a publicly-traded company. The terms stocks and shares are practically the same and represent ownership in a company.  When you own a share, you become a shareholder of a company and are automatically a party to the company’s profits and losses.  For example, when you buy 1 share of Reliance Industries, you become entitled to the profits and losses earned by Reliance Industries. Owning a share represents ownership, and you do get voting rights (in proportion to your shares) to decide on key company matters. 

Why do companies issue stocks? 

Companies issue stocks to: 

• Launch new products;
• Grow and expand in new markets and countries;
• Pay off their debts (loans);
• Build new factories, offices, etc;
• Buy new equipment. 

Why do investors buy stocks? 

We are all looking for ways to grow our hard-earned money. Stocks or shares have historically provided the best returns amongst all other asset classes. Investors buy stocks to: 

• Participate in the growth of the company;
• Earn regular income in the form of dividends;
• Earn bonus shares to increase their shareholdings;
• To acquire voting rights and be a part of key decisions. 

What is the stock market? 

The stock market is a place where buyers and sellers meet to trade i.e. buy and sell shares of publicly listed companies. The buyers and sellers do not physically meet but trade via a stock exchange like BSE and NSE. Read our detailed article on ‘what is a stock market’. 

What are the types of stocks?

Companies normally issue two types of stocks: 

• Common or Equity stocks &
• Preferred stocks

While both common and preferred stocks represent ownership in a company. Let us look at the primary difference between common stocks and preferred stocks. 

Parameters	Common Stocks	Preferred Stocks
Voting rights	Common shareholders get voting rights	Preferred shareholders do not get any voting rights
Claim on dividends	Common shareholders get dividend after preferred shareholders	Preferred shareholders are the first to receive dividends
Preference while winding up	Common shareholders are the last to get paid in the event of bankruptcy	Preferred shareholders get paid before common shareholders in the event of bankruptcy.
Cost of issue	The cost of issue is high	The cost of issue is low

What are stocks and bonds? 

Stocks and bonds are two completely different asset classes. While owning stocks makes you the owner of a company, a bond merely makes you a creditor or a lender. Let us look at the differences between stocks and bonds. 

Parameter	Stocks	Bonds
Ownership	You get ownership in the company	You do not get ownership in a company; you only become a creditor or lender to the company
Guaranteed Income	There is no guarantee of profits, dividends, or capital appreciation	Principal and interest income is guaranteed and collaterals are maintained against loans.
Risk	Stocks are risky as there is no guarantee of returns	Bonds are comparatively less risky as interest and principal repayment is guaranteed
Share in the company’s growth	Shareholders can participate in the growth and profits of the company.	Bondholders do not get to participate in the company’s profits or growth.
Voting Rights	Shareholders enjoy voting rights	Bondholders do not enjoy any voting privileges.
Preference while winding up	Common equity shareholders are the last to be paid in case of bankruptcy.	Bondholders get preferential treatment in the event of bankruptcy.
Add on benefits	Shareholders enjoy benefits such as bonus, share splits and can participate in a share buyback	Bondholders do not enjoy any additional benefits apart from the guaranteed return of capital and interest.

How do stocks work?

Stocks work on the concept of demand and supply in the market. 

• If more people are selling a stock, the stock price will fall &
• If more people are buying a stock, the stock prices will rise.  

People buy or sell stocks based on their projections of the future of a company. If they believe that a company will perform well, they will buy the stock and if they believe that a company will perform poorly, they will sell the stock.  Demand (buying) and supply (selling) help in determining the real value of a share in the market. 

How to make money in stocks? 

There are two approaches to making money in stocks: 

• Passive investing
• Active investing

A passive investment strategy is a long-term strategy that works on the ‘buy and hold’ principle. In passive investing, investors buy stocks with an aim to hold them for the long-term. Coffee can investing is a classic example of passive investing. Passive investing is suitable for investors with low-risk appetite, stock market knowledge, and a long time horizon.  The active investment strategy is a short-term strategy in which investors hold stocks for smaller periods of time, from minutes (arbitraging) to hours (intraday) and even days (position trading). The aim of active investing is to generate quick profits. Active investing is most suitable for individuals with a high-risk profile and who can dedicatedly track market movements. 

How to make money in stocks? 

If you were to believe the biggest stock market investor, Warren Buffett, the way of making money in the stock market is to select quality stocks and then hold them for the longest time. Warren Buffett has been a lifelong believer in passive investing.  To get you started, read the best stocks to buy for long term in India

Why should you invest in stocks? 

Stocks have a proven track record of outperforming all other asset classes like bonds, mutual funds, gold, and even real estate. When you invest in stocks you get:   Capital appreciation: When there is a rise in the price of the share  Dividend income: Dividend is a cash benefit distributed by the company Voting rights: Large shareholders or the collective majority of small shareholders can influence strategic decisions of the company. 

Conclusion

While stocks are potentially the profitable investment option, good quality stocks are the hardest to discover as it takes decades of knowledge, expertise, and a keen eye of the market fundamentals to select the best stocks for investment from the 5000+ stocks listed on the stock exchange.  [Suggested Reading: Best Large Cap Stocks to buy now in India] At StockBasket, we have discovered the best stocks to buy in India for your financial goals. From child education, home purchase and decor to child marriage and retirement, StockBasket has handpicked the best stocks to buy in India after analyzing over 2 million data points.  Also, to invest in the best long-term stocks in India, open a Demat account with Samco today and get access to a unique 3-in-1 Demat, Trading, and Mutual Fund investing account. Get started on a journey to create infinite wealth with Samco! [Suggested Readings: Best Multibagger Stocks to Buy now in India] We have done all the hard work so you don't have to. Simplify your stock investments by selecting StockBasket today!  P.S: StockBasket has outperformed Nifty50 by 9.37% in the period of 1 year after its launch (30th Sept 2019 - 30th Sept 2020).