When a company needs to raise money it can sell stocks. A stock is a sliver of ownership in a company. Meaning that one stock equals one vote. But not many people actually participate in the company. As part owner you get to share in the profits of the company, and as the company does better that stock is worth more.
A stock price moves according to the supply and demand for that stock. If there are more buyers than sellers the price goes up and if there are more seller than buyers the price goes down.
Additionally as part owner you get a dividend, or an amount paid per stock you own. This happens infrequently and the amount is usually small, usually under a dollar, but that gets paid to you (which will be taxed as income) or reinvested into more stocks. Reinvestment is a much better choice, it's free money and it's tax free.
Stocks are a good vessel to make money, since on average stocks gain 10% a year (not counting the boom in the late 90's), which is 5 times better than a money market account. However stocks are the riskiest kind of investment, there prices are dependent on the success of a company.
The United States uses three market indices that represent the market as a whole. Each indices represents a basket of different stocks.
Dow Jones Industrial Average
The DOW was created to measure the performance of railroad stocks. Today the DOW consists of 30 stocks that are from different market sectors.
National Association of Securities Dealers Automated Quotation System
The NASDAQ consists of 3,200 companies and is heavily reliant on technology stocks.
Standard & Poor's 500
Contains 500 companies and is maintained by S&P. This is generally the broadest and most reliable of the three. Companies in the S&P are the traded more often than companies than the other markets.
Growth, Income and Value stocks
All stocks are not created equal.
These stocks are expected to grow above average compared to the market average. Technology stocks are usually growth stocks. Dividends are not usually paid but rather the company retains the earnings. These companies are usually undervalued.
These are just the opposite of growth stocks. These companies generate cash and have little to no growth and little to no risk. Profits are usually paid to investors as dividends. Utility companies are good examples of income stocks.
These stocks tends to trade at a lower price relative to it's fundamentals (dividends, earnings and sales) and are believed to be undervalued. Common characteristics of value stocks are high dividend yield or low price-to-earnings ratio.
Blue chip, Glamor and Penny stocks
These stocks are issued by large and stable company's, they have little return and have very little risks. However they pay dividends when the company isn't doing so well.
This stock is just like a blue chip stock but they have a higher growth rate. They are also characterized by a faster rise than market averages.
These stocks are generalized as anything under $5 and are considered very high risk. It's rare that a penny stock sees a steady gain so I would avoid them.
Pick a good one!
This section is for people who would like to pick their own stocks.
It's hard to find the next break through stock but if you do a little research you could find a valuable addition to your portfolio.
Price to earnings ratio (P/E): Is the current stock price divided by the last twelve months earnings per share. Long story short this is your rate of return. A high P/E ratio shows that the stock is expected to grow and vice versa.
Price to sales ratio (P/S): This a good price indicator. Simply a stocks price over revenue per share. A P/S of less than 1 is good and 3 and over is bad.
Price to cash flow: Or share price over cash flow per share. This measures a company's future financial health and its an indicator of its value. This is a more real way to get value because it takes out accounting issues.
These are just a few of the ways an individual can rate a company and hopefully gives you a start.
The goal of a business is to make money, and when they do they either re-invest that money or they pay dividends to stock holders.
Dividends are paid to the share holder in a check and are paid per share, usually on a fixed schedule.
Dividend-reinvestment plans, or DRIPs, allow shareholders to use dividends to automatically buy more shares.
Everyone could use more cash but DRIPs allow you to use more free money to buy shares! So I recommend DRIPs.