The Value of Stock

A stock's value can change at any moment, depending on market conditions, investor perceptions, or a host of other issues.

A stock doesn't have a fixed price, or value. When investors are buying the stock, the price tends to go up. But if they think the company's outlook is poor, or if the overall market is weak, they either don't invest or sell shares they already own. Then the price of the stock tends to fall.

But price is only one way to measure a stock's value. Return on investment — the amount you earn by owning the stock — is another. To assess return, you add any increase or decrease in price from the time of purchase and any dividends the stock has paid over that time. Then you divide by the amount you invested to find percent return. As a final step, you can find the annualized return by dividing the return by the number of years you owned the stock.

The peaks and valleys in the price of a stock dramatically illustrate how value changes.

 

 

All stocks don't act alike. One difference is how closely a company's business is tied to the condition of the economy. Cyclical stocks are shares of companies that respond predictably to the economy's ups and downs. When things slow down, their earnings typically fall, and so does their stock price. But when the economy recovers, earnings rise and the stock price goes up. Airline and hotel stocks are typically cyclical: People tend to cut back on travel when the economy is slow. In contrast, stock prices for companies that provide necessary services and staples, such as food and utilities, tend to stay fairly stable.

Many investors attempt to time the market by buying a stock before others want it and selling before they decide to unload it. Getting the timing right means paying attention many details, including but not limited to:

• The rate at which the company's earnings are growing
• Competitiveness of its products or services
• The availability of new markets
• Management strengths and weaknesses
• The overall economic environment in which the company operates

You may make money with stocks by selling your shares for more than you paid for them or by collecting dividends on the stocks — or both.

The profit you make on the sale of stock is known as a capital gain. Of course, it doesn't all go into your pocket. You owe taxes on the gain as well as a commission on the sale, but if you've owned the stock for more than a year, it's a long-term gain. That means you may pay the tax at a lower rate than you pay on your earned income or on interest income.

Dividends are the portion of the company's profit paid out to its shareholders. A company's board of directors decides how large a dividend the company will pay, or whether it will pay one at all. Typically, large, mature companies pay dividends, while smaller ones tend to reinvest their profits to fund growth.

Dividends are reported on your year-end 1099 statements you receive from financial institutions. You should discuss dividend income with your tax adviser.

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