What Are Dividends - Stock Dividends

What Are Dividends – Stock Dividends

If you are new to investments, you may or may not know what dividends are. Hopefully you understand what a stock is and how it makes money. It is simply a piece of a company that you can own. Let’s say a company has 1,000,000 shares of stock that cost $10 each. You can purchase 10 shares for $100 dollars.

How do you make money from stocks?

Over time, the value of these shares of stock may increase or decrease. This is based on the supply and demand principle of economics. As more people want to buy stock from a particular company, the price of that stock increases. The reverse happens when more people are selling their shares, the price goes down.

Where do dividends fit into all of this?

When a corporation is doing well, they may decide to pay dividends. This is a payment to their shareholders separate from stock increases. The increase from their stock doesn’t come from the corporation, but the dividends do.

The amount of dividends depends on the corporation’s net income and how much they are willing to pay. It could be anywhere from $.25 to $1 or more per share. So, if you have 100 shares of stock of a company and they decide to issue $.50 per share in dividends, you will make an extra $50. This is usually done on a quarterly basis.

Should you search for dividend paying stock?

Some companies almost always pay dividends. These stocks are popular among retirees because it is another source of income. Whether or not you look for dividend paying stock is entirely up to you.

I wouldn’t suggest you buy stock only based the fact that they pay dividends. You should conduct proper research of any company you are willing to buy stock in and there is no problem making dividends one of your criteria.

Of course, if you are young, you have more time and can take more risk. Many of the younger companies don’t pay dividends because they are still becoming established, but they might give you a much higher return.

How Do Bonds Work Bonds 101

How Do Bonds Work? – Bonds 101

For this articles I’m going give you the basics, so you’ll be able to answer “How do bonds work?”. During my undergrad I had a finance class that dedicated 1/4th of the semester to bonds. Lucky for you, I’ll cover what every basic investor should know before investing in bonds. Bonds are another popular investment and teens can invest in bonds, too. They are less risky than stocks and therefore usually have a smaller return. In other words, you’ll probably make more money off of stocks. It is often recommended to make bonds only about 30% of your portfolio.

Bonds may be a little less nerve racking than stocks. If you check your stocks everyday, you might give yourself many unnecessary anxiety attacks. If you have bonds, there are no prices to check.

A bond is a certificate of debt issued by a government or corporation guaranteeing payment of the original investment plus interest by a specified future date, according to the dictionary. This means that the government or a business sells a bond to you for a certain amount of money and after a certain period of time they will pay it back and then some.

For example, you may buy a bond from a corporation for $1,000 and after 10 years they will pay you back the $1,000 dollars plus, let’s say 6%, which would be $60. All your really doing is lending someone money and getting paid for it.

Different Types of Bonds

There are several different types of bonds. There are government bonds, corporate bonds, and municipal bonds. Government bonds are issued by the U.S. government, corporate bonds are issued by corporations, and municipal bonds are issued by local and state governments.

You may have gotten savings bonds from relatives or as awards. These are EE bonds and are available in the denominations $50, $75, $100, $200, $500, $1,000, $2,000, and $10,000. The U.S. treasury also offers I Bonds, Treasury bills, Treasury notes and other bonds. Government bonds are usually the least risky bonds.

Corporate bonds are rated based on the quality and safety of a bond. The higher the rating, AAA the highest, the better, and D is the worst. The lower the rating the more risk there is, but this also means you will probably get a much higher return. A bond with a D rating may promise a 20% return, but they are also probably very unlikely to pay you. Low rated bonds are often called junk bonds.

Mutual Funds Vs Stocks

Mutual Funds Vs Stocks (Equities)

Understanding mutual funds vs stocks and the benefits of each will help increase your basic investment knowledge, while better preparing you to make an informed decision on which investment is right for you. So what do they have in common? You might be thinking “They both have to do with owning a company, right?”. A better question to ask is, “what is the better about one than the other?”

Both of these investments are meant to make you money, and which one is better depends on what you are looking for.

Do you enjoy researching and following the ups and downs of the market?

You may find yourself leaning towards investing in stocks. When you invest in stocks, you are investing in just one company at a time.

You decide which companies you’re going to buy. You decide when you’re going to buy them. You decide how many shares you are going to buy.

When investing directly in stocks, you are in control. The problem is, you may feel inexperienced and unsure about your choices. Maybe if you’ve been investing longer you would have known not to put $1,000 into that company that lost you so much?

When investing in stocks, that is not the way to look at it. Yes, researching and knowing a little bit about the company, both in the past and present, might help and is completely necessary, but you have just as much of a chance to gain a lot from an investment as an experienced investor. Besides, everyone starts somewhere, and it’s best to learn from your own mistakes.

Do you want to invest but worry about the risks?

When you invest in mutual funds, you are investing in several companies at once. A money manager of the mutual fund you chose is deciding which companies to buy, when to buy them, and how many shares.

It’s important to remember that just because you are investing in a mutual fund doesn’t mean there is no possible way you could lose money. There are risks just as when you invest in stocks directly yourself.

There is less effort on your end with mutual funds, but there are other perks, too. You are able to obtain a large amount of diversification that you may not have been able to get with only your money. You’re pooling all your money with other investors and the money manager is able to stretch your money farther.

Either way, you’re making money

And either way, you could lose money. However you choose to invest, stocks, mutual funds, bonds, etc. just remember the risks you are taking. In one instance, you may be doing more work yourself, but in either instance, you are not guaranteed anything.

Stock Market Definition

Stock Market Definition – Investing 101

The stock market. It sounds like a simple concept. It’s a market for stocks. You go to the stock market and buy stocks just like you go to the supermarket and buy food, right?

You can browse stocks like you browse through chips down the snack isle, but what you choose to buy and how you buy them is very different. Instead of choosing what you like best in a few seconds, it takes a lot more careful thinking and instead of jumping on line at the cash register, well, that’s just entirely different.

Here are the basics of the stock market.

1. What are stocks?

When a corporation wants to expand or needs to raise money for their company, they may decide to sell stock. A stock signifies ownership in the company. When an investor buys a share of stock they are called a shareholder and become a part owner of that company.

Yes, that means if you own a share of Disney, you are a part owner of the company. With one share, you don’t get much say in anything, but you can vote at the annual shareholder meetings.

When you invest in a company, you may get a stock certificate. The stock certificate is a written indications or proof that you own part of the company. Most brokerages will keep the stock certificates with them. This is a good thing so you don’t have to worry about losing or damaging them.

If you want to own a purchase shares of a company, you will need a brokerage firm to facilitate the transaction. They are good gift ideas. You can buy one share of many different companies that they offer and the certificate is dressed up and looks very fancy. You can buy them framed as well.

2. Stock Exchange

The three major stock exchanges are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the National Association of Securities Dealers Automated Quotations System (NASDAQ). A stock exchange is a place where stocks and other securities are bought and sold.

3. Buy and Hold vs. Trading

There are two different common ways to buy and sell stock. Long term investors often use the buy and hold method. This is pretty self explanatory. You buy a certain amount of stocks and you keep them long term. Usually this means you don’t sell them for at least 1 to 5 years.

With trading, you buy a sell very often. Sometimes you may buy and sell the same stock in one day. The point is you are trying to get the short term gains. I wouldn’t recommend this method, especially if you are trying out. If you are a trader, you would need a certain brokerage that caters to it.

Some say that the gains made through trading over the long term aren’t any higher than the gains from a well diversified buy and hold portfolio.

4. Diversify

It is very important that when you have a portfolio it be well diversified. A diversified portfolio means that you don’t have all your eggs in one basket. You must have a wide variety of companies in order to minimize risk.

If you have $10,000 all in one company and the company loses 20% for the year, you have a total loss of 20%. If you hade $10,000 divided between 5 companies evenly, $2,000 each, and the same company goes down 20%, but the rest go up 10%, you will gain 20% in the end. Basically, if you have several different companies in different industries and one goes down, the ideal effect is that an increase in another will help balance it out and relieve some of the burden.

Of course, ideally you will want all of the companies to go up, but it’s impossible to predict, so you might as well reduce the risk.

5. Stock Symbol

The Stock symbol is a short symbol used on the stock exchange to symbolize each company. For example, the stock symbol for Johnson & Johnson is JNJ.

6. Fundamental Analysis

Fundamental analysis is used to analyze stocks. You wouldn’t go out and buy just any old car without knowing anything about it and you shouldn’t go out and buy any old stock without knowing anything about it.

With this type of analysis you would examine the company. A great way to start is by finding a company through certain criteria at an online stock researcher such as at MSN money’s stock screener. You type in what you want such as the industry, market cap, dividend yield, and P/E ratio.

Do you have no idea what I am talking about? A great book to read and find out more about researching stock you should read The five rules for successful stock investing. They will go into all the details about analyzing stocks.

Here is just a basic background about investing in stock market.

what is a corporation how does it work

How do Corporations Work? The Basics Regular People Need to Know

If you’re going to invest in corporations through stocks, mutual funds, a 401(k) plan, exchange traded funds (ETFs) or some other means, it’s important to understand the basics of how they work.  In keeping with that theme, the purpose of this article isn’t to provide an exhaustive, technical explanation of what a corporation is and how one works, but to focus on fundamental principles related to corporations that you need to understand so that you can be a more informed, knowledgeable investor (or even a potential business owner!).

A corporation is a separate legal entity

A corporation is a legal entity that is recognized in the eyes of the law.  That is extremely significant, because as a legally recognized entity a corporation has certain rights, such as the right to own property, to open and maintain bank accounts, to hire employees, to protect its rights in court, and so on. With these rights corporations also have responsibilities, such as the responsibility to pay taxes and to otherwise operate within the law.  Finally, a corporation’s ongoing status as a separate legal entity is not automatic.  The owners of corporations must make annual filings, pay fees, and follow certain legal formalities.

The owners of a corporation have limited liability

One of the greatest benefits and protections of investing through a corporation is that it provides limited liability to its shareholders.  In other words, when it comes to the debts or legal liability of a corporation, shareholders are only at risk to the extent of the value of the stock they own.  Said another way, individual shareholders are shielded from the debts and liabilities of the corporation they own.

The fact that shareholders have limited liability does not mean that they (or corporate employees) are exempt from prosecution if they engage in criminal activities.  In other words, people who own and operate a corporation cannot evade taxes, intentionally dump chemical waste in the town water supply, or engage in fraud and the avoid criminal prosecution simply by hiding behind “the company.”  In all such cases the authorities can criminally prosecute those responsible for breaking the law because it’s recognized that you can only put people in prison, not corporations.[1]  Following are some practical examples to illustrate how these principles work.

  1. You sell bananas out of your home as an individual.  If a customer comes over and slips on a banana peel and is injured then you could personally be sued for damages.  In other words, if there was a $200,000 judgment against you then you could stand to lose your savings, home, cars, and other assets.
  2. Assume the same facts as Example #1, except you are the owner of the corporation Deadly Bananas Inc. (“DBI” for short).  In that case the clumsy customer could only name the corporation in the lawsuit, not you personally.  In the unfortunate event that DBI lost the lawsuit and could not pay the full amount, the clumsy customer could not come after your personal assets such as your home, car, savings, investments, etc.
  3. You sell bananas out of your home as an individual.  You place a large order on your personal credit card.  If your business were to fail then you would be personally liable for the credit card balance.
  4. Assume the same facts as Example #3, except this time, as the owner of Deadly Bananas Inc., you get a loan from a bank to purchase a large shipment of bananas.  If the corporation is later unable to pay back the loan then the bank can seek to recover corporate assets to pay it off, but they cannot lay claim to any of your personal assets (assuming you didn’t sign something personally guaranteeing the loan!).
  5. You steal a massive crate of bananas and purposefully set banana peel traps all over town in an intentional attempt to cause chaos, injury and mayhem.  You could be criminally prosecuted for your actions, whether you were acting in your capacity as an individual or as the CEO of DBI.

Corporations have continuity of life

If you run your banana business as an individual, which is technically known as operating a “sole proprietorship,” then the business will die when you do.  Granted someone else could step into your shoes and continue to run the same business, but they would be doing business, signing contracts, and developing customer relationships in their name, not yours.  On the other hand, if you do business as Deadly Bananas Inc. (you really need to do something about that name) then the corporation will live on as a separate, distinct legal entity as long as it makes the necessary legal filings, pays the appropriate fees, etc.  In summary, there are many, many corporations in business today that have long outlived their original owners.

Corporations allow for the easy transfer of ownership

You can easily transfer ownership in a corporation by selling (or giving) the stock in the company to someone else.  Because all of the company’s property, contracts and business relationships are already in the name of the corporation, the business can continue to roll on just as it did before; all that’s happened is that the company has a new owner.  On the other hand, if someone wanted to by your unincorporated, home-based business, then they would have to do so one asset at a time.  And what would you do about liabilities?  For example, what if you had a shipment of 10,000 bananas on order?  Unless you made special arrangements, that order would still be in your name and you would have to pay for it.  But again, if you were incorporated and sold the stock of your company then not only would ownership of the assets transfer with the stock, but responsibility for the debts and other liabilities of the company would transfer as well.

Ownership in corporations can easily be divided

Generally speaking, ownership in a corporation is determined by how many shares you have in the company.  The owners of a corporation have the ability to divide their shares, something that provides them with a substantial amount of flexibility in managing the overall structure of the company.  Following are some examples to illustrate these principles.

  1. A company has 10 shares outstanding, and you own 7 of them.  That means that you own 70% of the company (your 7 shares divided by 10 total shares).
  2. Assuming the same facts in Example #1, you want to sell 1% of the company to 3 different investors.  The problem is that each share of the company has an ownership percentage of 10%.  The solution?  You could increase the total shares outstanding by doing a 10 for 1 (or 10-1) stock split.  That would increase the number of shares you own to 70 (7 shares x 10) and the total number of company shares outstanding to 100 (10 shares outstanding x 10).  Now you could sell one share (each equal to 1% of the company) to 3 different investors, leaving you with 67 shares.
  3. True or false – By increasing the number of your shares you increase the overall value of the company?  The answer is false; stock splits only increase the number of shares outstanding, not the value of the company itself.  For example, if a company is worth $100,000 and there are 1,000 shares outstanding then each share is worth $100 ($100,000 divided by 1,000 shares).  If the company did a 100 for 1 (or 100-1) stock split then the total shares outstanding would increase to 100,000 (1,000 shares outstanding x 100), but then each share would be worth $1 rather than $100.

Stock can be divided into classes

If all a corporation has is “stock” then it is generally considered to be “Class A common stock.”  Each share of Class A common stock has equal voting and economic rights with respect to the company.  But other classes of stock can be created which have different voting and economic rights.  These principles can be illustrated as follows.

  1. A couple wants to give shares in their company to their children, but they want to maintain control of the management of the company.  They create Class B shares and give these to their children.  These shares have equal economic rights to the Class A shares held by the parents, so the children can share in the profits of the company just as if they had Class A shares, but the Class B shares do not have voting rights.  As a result, the children do not have a say on who will be officers in the company, or in other major decisions such as whether the company will merge, acquire, or be acquired by another company, etc.
  2. The owners of a company want to raise additional funds for expansion, but they don’t want to give away a significant amount profit potential in the process.  The owners find a group of investors who want a higher potential investment return than what is offered by interest bearing investments, but they don’t want to take on an excessive amount of risk.  In this case the owners of the company could issue “preferred stock” to the investors.  Generally speaking, preferred shareholders are first in line when corporate distributions are made and are promised a certain rate, but once they receive an agreed upon amount then the rest of the distributions belong to the Class A shareholders.[2]

Corporations can be “publicly held”

One huge advantage of corporations is that they can “go public,” or be “publicly held.”  In other words, corporations can be listed on a public stock exchange such as the NASDAQ or the New York Stock Exchange, which enables the shares of the corporation to be sold to the general public.  And what is the significance of a company being publicly traded?  It means with a little bit of money and a few clicks of a mouse (or a phone call) that you and I can become part owners of any company listed on a stock exchange: Exxon, Walmart, Google, Bank of America, GE, IBM, just to name a few.

While the process going (and remaining) public is long, complicated, expensive, and involves a tremendous amount of work on the part of a company, it also provides extraordinary opportunities.  It gives the owners of the company an opportunity to “cash out,” or to sell some of their stock to the public.  And for the company as a whole, it provides a means to raise capital (which means raising money) from a huge pool of investors in order to fund projects that will (hopefully) further drive the growth of the company.

Corporate governance

The corporate organization provides a framework to govern the affairs of a company so that it acts in the best interests of the shareholders while also being a responsible corporate citizen.  This is primarily done through the board of directors.  The shareholders use their voting rights in the company to elect members to the board who then select a chairman.  One of the main responsibilities of the board is to select a chief executive officer (“CEO”) to run the day-to-day operations of the company as well as to monitor that person’s performance.  Boards of directors generally grant a degree of latitude to CEOs to run a company according to their best business judgment.  However, if the company under-performs for an extended period of time and/or engages in questionable business practices then the board has the power to replace the CEO.

As a practical matter, corporate governance is of greater importance in companies whose stock is widely held by many owners as opposed to a company where stock ownership is concentrated.  For example, if a shareholder owns 75% of a company then they can effectively make all of the decisions: they can elect all members of the board, appoint themselves as chairman of the board, and even appoint themselves CEO.  In addition, no matter how poorly such a “closely held” company performs, the only way a majority owner can lose their job as CEO is if they fire themselves!  On the other hand, at a very large company the CEO may own less than 1% of the outstanding stock.  In such cases the CEO’s performance and the relationship they have with the board of directors is more important and takes on a greater degree of formality.

As a shareholder you generally want a board of directors to take a balanced approach in overseeing the affairs of the company.  On the one hand, you don’t want them so involved that they interfere with the CEO’s running of the day-to-day operations of the company.  On the other hand, you don’t want them to be overly passive either, effectively rubber stamping everything the CEO does and asks for.  Such an approach creates an environment where there is a sense of complacency and a lack of accountability, which is a recipe disaster.  In summary, an effective board is informed and involved, mostly using its position to influence rather than interfere, but also acting decisively when needed to protect the overall interests of the shareholders.

Corporations do NOT have a life of their own

Following on the concept of corporate governance, one final thing I want to point out is that corporations themselves are not inherently good or evil; they don’t make smart or dumb decisions; they don’t hire or fire people; they are neither charitable nor ruthlessly capitalistic.  In fact, corporations don’t make any decisions at all.  Only the people who are part of corporations can do that.

Applying this concept to one of the examples above, was it really “Deadly Bananas Inc.” or, more generally, “The Corporation,” that deviously spread banana peels all over town in an attempt to wreak havoc on the general public?  Of course not, the corporation itself is simply a set of documents locked away in some filing cabinet.  No, the real culprit was the individual(s) at the company who was orchestrating all of the mayhem.  While it may sound obvious that, for good or bad, people are always behind the acts of corporations, I point it out because it’s a frequently overlooked concept.

Summary: Corporations provide a powerful means to do business and to raise capital

In reviewing all of the above characteristics of a corporation it becomes much easier to see why they’re a very attractive means to do business.

  • Separate legal entity – Assets and liabilities can be in the name of the company.
  • Limited liability – Shareholders are not personally liable for the actions and debts of the company.
  • Continuity of life – A corporation can exist indefinitely.
  • Transferability of ownership – Shares of a corporation can be transferred, bought and sold.
  • Division of shares – Ownership in a corporation can be divided in an infinite number of ways.
  • Corporate governance – Corporations have formal processes to appoint officers and to oversee the business.

For all of the above reasons, a business organized as a corporation has intrinsic value.  In other words, even if a corporation had no assets or liabilities, meaning that it was just a shell company, it would still have value in and of itself because it’s organized in a manner that’s extremely effective for doing business…it just needs someone to pull the switch to get the business going.  And it’s for all of these reasons that in terms of assets owned, goods and services produced, and people employed, the corporation is the most dominate form of business in the United States (and the world!).

[1] While this is true, it’s also important to note that a corporation as a separate “person” can get hit with legal, administrative and operating sanctions that can hamper its ability to do business.  For example, if an oil company has a major industrial accident then the corporation can be hit with fines and/or lose the right to drill in certain areas.  In extreme cases a company can even get shut down altogether.

[2] I will write about preferred stock in more detail at a later time.  The point I am trying to illustrate for now is that a corporation’s stock can be divided into classes.