Stock Market for Dummies -- Stock Market Basics

As you saw in the previous article, Stock Market for Dummies -- Requirements, “Dummies” makes for an attention-getting clever title, but dummies are not going to do well trading stocks.

Assuming you think you meet the requirements discussed in that article, this and future articles will outline some of the basics you need to know to get started in the stock market for beginners.

Here are the stock market basics. A company -- corporation -- issues shares of stock to raise capital. Big blocks of shares are sold to institutions and large investors by one or another of the Wall Street mega-brokers that the company uses to get the stock out into the stock market. The proceeds of these “public offerings” are then transmitted to the company, less the commissions, fees, percentages, whatever, that the mega-broker gets for handling the offering.

The mega-broker sets a suggested offering price, but usually most of the stock is sold out at various prices, higher or lower. After the stock gets into institutional or large investor hands, then much of it is then offered to other investors, including the public, or other institutions through the stock market, on various stock exchanges such as the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), NASDAQ, etc.

After the public offering, the company gets its money, and is then out of the loop. Whatever happens to the price of the stock after that neither enriches nor beggars the company.

The investors and speculators who have bought some of the stock naturally would like to see the price of the stock go up.

But even though the company no longer has a stake in what happens to the stock previously issued, it still wants to see the stock price go up, for at least a couple of reasons. First, some of the stock that the company has authorized to be issued has likely not been put onto the market. It is held to give out to executives and employees as bonuses or to be put into a company retirement fund. Naturally, the executives and employees stand to make more money when putting some of their bonus stock onto the market and selling it, the higher the price is in the market. Second, the higher the stock price in the market, the more money the company can get per share when it comes to the market again to offer (float) another issue of stock to raise more money..

Back in the olden days, the purpose of most investors in buying stock was to get dividend income. A profitable company would distribute some of its profits to shareholders in the form of dividends -- a per share payment. As the company increased in profitability, the amount of the dividend per share would increase. That caused the stock price to increase. The amount of the share divided by the current share price is called the “yield”. A $2.00 dividend on a $60.00 current price stock yields 3.33%. Whatever the yield on a stock is, it has to compete with the interest or other proceeds of other investments, such as savings accounts, CDs, bonds, etc., even real estate. What each of those pay affects all the others, including what the price of a stock will be that pays a certain dollar dividend per share.

Remember that as the profitability of a company goes up, the dividend likely goes up. That usually causes the stock price to go up. If a company is paying a $2.00 dividend, and the price is only $40.00, that means the yield is then 5.00%. If other investments are paying only 3% or 4%, someone, a lot of someones, are going to buy some of that stock from others by offering much more than the current $40.00. Someone will want to sell some, so they can get the profit to buy a toy or pay alimony or whatever. Eventually, the price of that $2.00 dividend stock will approach maybe $50.00 so as to yield 4% to a recent buyer.

The objective of the investor is to earn dividend income. If the price of his stock goes up (or down) and he sells some or all, he has made a profit (or loss). He makes a so-called capital gain (or loss). But he is still an investor.

Now, “speculating” is not something that prudent investors are supposed to do. But, there are a lot of people who like to call themselves investors, who are in actuality speculators. It's the same as some whores like to call themselves “escorts” or “sex workers”. Both are evidently seeking some better level of acceptance or esteem by “genteel” society. Note that I am not denigrating either speculators or whores. Both provide vital services. (Take that, any religious or other prudes reading this -- feel free to leave.)

The speculator does not care so much about dividends. Often, he regards them as a nuisance because they complicate his strategies somewhat around dividend declaration and payment time. The speculator buys and sells primarily to make income from his buys and sells. He wants to buy low and sell high. Or in the case of short selling, to sell high a stock loaned to him, then buy back low and return what he previously borrowed and sold.

For various reasons, many of which I don't understand, and don't have room here to explain, even if I did, investing for dividends is mostly dead. DEAD. I will just mention a couple of reasons, without explanation: Counterproductive government regulations and taxes that punish prudence and reward excess and recklessness, and corporate and mega-bank and mega-broker chicanery,

The stock market is now primarily a mechanism to facilitate speculation. Investing is dead for most. Yes, there is still Warren Buffet and a few other “Masters of the Universe”, but the average person will never be able to get into their game, today.

There are many reason why the average person gets screwed as an investor. Personal taxes, suffocating paperwork and regulatory requirements if he tries to structure his finances to reduce personal taxes, unregulated corporate accounting fraud, inflation that eats up dividend income and modest capital gains if and when received. In fact, most people's “investments” actually lose value (real value -- purchasing power) over time due to inflation and taxes that actually confiscate inflation-adjusted capital.

The only way most people can now hope to maintain purchasing power, or even increase it, is through speculation.  Investing for dividends is mostly dead, as I mentioned above.  Dividend income, even from so-called “good paying” companies is insufficient to overcome taxes and inflation.  The stock prices of most companies have been static -- adjusted for inflation -- on average for at least a couple of decades.  Given the continuing economic and political deterioration -- even possible collapse -- that inflation adjusted capital gains situation is not going to improve.  In fact, it is likely to deteriorate further.

So what is an investor to do?  Learn to trade -- to speculate -- or fuggedaboudit!  “Stock Trading for Dummies”?  Those days are over.

This concludes this essay, Stock Market for Dummies -- Stock Market Basics.  I plan further in this series on the stock market for beginners, depending on the reception I get.  When I post a new Hub in the series, I'll put a link here.  You could also sign up and click over in the right column to become a fan so you will be notified of all my new Hubs as they are published.