What is an IPO?
All companies have to start somewhere, and often, it involves having the founders invest a chunk of their own money in the hopes of eventually growing the business. But as small, private companies start to gain traction, many come to find that they need outside financing to continue growing, and therefore decide to go public. And that's where IPOs come in.
An IPO, or initial public offering, is the process by which a privately held company begins selling stock to outside investors, thus becoming a public company. From that point on, the company can raise the capital it needs by selling shares, but it must also comply with a strict set of reporting guidelines, as established by the Securities and Exchange Commission (SEC).
How IPOs work
Most companies get their initial funding by emptying their bank accounts, taking out small business loans, turning to private investors or venture capatialists, or a combination thereof. But there often comes a point where more money is needed for a business to experience the growth it desires.
Enter the IPO. An IPO is the process by which a company first offers shares of its stock to new investors, thereby going public. And it's a lengthy process at that.
What initially happens is that the company in question hires an investment bank (or several banks) to come in and underwrite the IPO. That bank will then put up a sum of money to fund the IPO and agree to buy the shares being offered before they're actually listed on a public exchange. What's in it for the bank? Ideally, profits in the form of paying less per share than what they end up selling for publicly.
To proceed with an IPO, a registration statement must be filed with the SEC. That statement contains key information about the issuing company, including financial and ownership details. Once the SEC approves the IPO, a date for it is set. The underwriter will then put forth a prospectus, which is a document outlining the issuing company's finances. The underwriter will also work with the issuing company to set an initial stock price for when shares are made available to new investors.
Why go public?
The primarily benefit of going public is gaining access to a world of capital. That money can then be used for things such as expansion, research and development, marketing, and whatever else a company needs to grow and keep making money. But there's a flipside, and it's that once a company goes public, it's required to adhere to SEC reporting guidelines, which can be rather strict.
Specifically, once public, a company will need to put out regular disclosure statements and share other such financial information with the world. Furthermore, that company will also need to start answering to its shareholders, which means that management loses some control in exchange for that additional funding. Still, it's often a reasonable trade-off to make.
Investing in Growth Stocks
Investing in growth stocks can be a great way to earn life-changing wealth in the stock market. The key, of course, is to know which growth stocks to buy -- and when.
To help you get started, here’s a handy guide to growth investing. With these tools and strategies, you’ll be able to position your portfolio for long-term success with growth stocks.
What is a growth stock?
Growth stocks are companies that increase their revenue and earnings faster than the average business in their industry or the market as a whole.
Often a growth company has developed an innovative product or service that is gaining share in existing markets, entering new markets, or even creating entirely new industries.
Businesses that can grow faster than average for long periods tend to be rewarded by the market, delivering handsome returns to shareholders in the process. And the faster they grow, the bigger the returns can be.
Unlike value stocks, growth stocks tend to be more expensive than the average stock in terms of metrics like price-to-earnings, price-to-sales, and price-to-free-cash-flow ratios. Yet despite their premium price tags, the best growth stocks can still deliver fortune-creating returns to investors as they fulfill their awesome growth potential.
Investing in Value Stocks
Value investors want to buy stocks for less than they're worth. This concept certainly makes sense -- after all, if you could buy $100 bills for $80, wouldn't you do so as often as possible? Of course, this is easier said than done. Here's an overview of what value stocks are, examples of some excellent beginner-friendly value stocks, and some key concepts and metrics that value investors should know.
What are value stocks?
Value stocks are publicly traded companies trading for relatively cheap valuations relative to their earnings and long-term growth potential.
Here's one important concept for all investors to understand. Most stocks are generally classified as either value stocks or growth stocks. Generally speaking, stocks that trade for valuations below that of the average stock in the S&P 500 are considered value stocks, while stocks with above-average growth rates are considered growth stocks. Some stocks have both attributes, or fit in with average valuations or growth rates, so whether to call them value stocks depends on how many characteristics of such stocks they have.
Value stocks generally have some common characteristics. They typically are mature businesses, have steady (but not spectacular) growth rates, and have relatively stable revenues and earnings. Most value stocks pay dividends, although this isn't a set-in-stone rule.
Some stocks clearly fit into one category or the other. For example, 130-year-old spice manufacturer McCormick (NYSE:MKC) is clearly a value stock, while fast-moving Tesla (NASDAQ:TSLA) is an obvious example of a growth stock. On the other hand, some stocks can fit into either category. For example, there's a case to be made either way for tech giants Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT).
However, that a stock is classified by someone as a value stock doesn't necessarily mean it's a good value right now. That's where your analysis must come in.
Let's take a look at three excellent value stocks
Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B)
Procter & Gamble (NYSE:PG)
Johnson & Johnson (NYSE:JNJ)
Dividend stocks can provide investors with predictable income as well as long-term growth potential. However, not all dividend stocks are great investments, and many investors aren't sure how to start their search.With that in mind, here's a list of dividend-paying stocks you might want to consider. Get a rundown of the most important things to look for when you're evaluating dividend companies.
Five Dividend Aristocrats to buy
The Dividend Aristocrats Index, which is maintained by S&P Indices, is a great place to start. This is a collection of several companies that have increased their dividends for at least 25 consecutive years. That means that every company in the index successfully gave investors raises not just during the good times in the market, but also during more volatile downturns, such as the dot-com crash of the early 2000s, the financial crisis of 2008-2009, and the COVID-19 pandemic so far. They may be a safer investment than the average dividend-paying stock.
Once you have a firm grasp on how dividends work, a few key concepts can help you find excellent dividend stocks for your portfolio.
Payout ratio: A stock's payout ratio is the amount of money it pays per share in dividends, divided by its earnings per share. In other words, this tells you what percentage of earnings a stock pays to shareholders. A reasonably low payout ratio (say 60% or less) is a good sign that the dividend is sustainable.
History of raises: It's a very good sign when a company raises its dividend year after year, especially when it can continue to do so during recessions and other tough economic times like the COVID-19 pandemic.
Steady revenue and earnings growth: When looking for the best dividend stocks to own for the long term, prioritize stability in the companies you consider. Erratic revenue (up one year, down the next) and all-over-the-board earnings can be signs of trouble.
Durable competitive advantages: This is perhaps the most important feature to look for. A durable competitive advantage can come in several forms, such as a proprietary technology, high barriers to entry, high customer switching costs, or a powerful brand name, just to name a few.
High yield: This is last on the list for a reason. A high yield is obviously preferable to a lower one, but only if the other four criteria are met. A high dividend is only as strong as the business that supports it, so compare dividend yields after you make sure the business is healthy and the payout is stable.
Dividend stocks are long-term investments
Of course, even the most rock-solid dividend stocks can experience significant volatility over short periods. There are simply too many market forces that can move them up or down over days or weeks, many of which have nothing to do with the underlying business itself.
So while the companies listed above should make great long-term dividend investments, don't worry too much about day-to-day price movements. Instead focus on finding companies with excellent businesses, stable income streams, and (preferably) strong dividend track records, and the long term will take care of itself.
How to Invest in Index Funds
An index fund is an investment that tracks a market index, typically made up of stocks or bonds. Index funds typically invest in all the components that are included in the index they track, and they have fund managers whose job it is to make sure that the index fund performs the same as the index does.
Your 3-step process to investing in index funds
Pick the index that you want to track.
Choose a fund that tracks your selected index.
Buy shares of that index fund.
1. Pick an index
There are hundreds of different indexes you can track using index funds. The most popular index is the S&P 500 Index, which includes 500 of the top companies in the U.S. stock market. Here's a short list of some additional top indexes, broken down by what part of the market they cover:
Large U.S. stocks: S&P 500, Dow Jones Industrial Average, Nasdaq Composite
Small U.S. stocks: Russell 2000, S&P SmallCap 600
International stocks: MSCI EAFE, MSCI Emerging Markets
Bonds: Bloomberg Barclays Global Aggregate Bond
In addition to these broad indexes, you can find sector indexes that are tied to specific industries, country indexes that target stocks in single nations, style indexes that emphasize fast-growing companies or value-priced stocks, and other indexes that limit their investments based on their own filtering systems.
2. Choose the right fund for your index
Once you've chosen an index, you can generally find at least one index fund that tracks it. For popular indexes like the S&P 500, you might have a dozen or more choices all tracking the same index.
If you have more than one index fund option for your chosen index, you'll want to ask some basic questions.
First, which index fund most closely tracks the performance of the index?
Second, which index fund has the lowest costs?
Third, are there any limitations or restrictions on an index fund that prevent you from investing in it?
And finally, does the fund provider have other index funds that you're also interested in using?
The answers to those questions should make it easier to pick the right index fund for you.
3. Buy index fund shares
To buy shares in your chosen index fund, you can typically open an account directly with the mutual fund company that offers the fund. Alternatively, you can open a brokerage account with Interactive Private Equity that allows you to buy and sell shares of the index fund you're interested in.
Why invest in index funds?
Investing in index funds is one of the easiest and most effective ways for investors to build wealth. By simply matching the impressive performance of the financial markets over time, index funds can turn your investment into a huge nest egg in the long run -- and best of all, you don't have to become a stock market expert to do it.
Investors find index funds especially useful for many reasons:
Minimize your time spent researching individual stocks. Instead, you can rely on the fund's portfolio manager to invest in an index that already includes stocks you want to invest in.
You can invest with less risk. Most indexes include dozens or even hundreds of stocks and other investments, and the diversification leaves you less likely to suffer big losses if something bad happens to one or two companies in the index.
Index funds are available for a wide variety of investments. You can buy stock index funds and bond index funds, which cover the two big parts of most people's investment strategies. But you can also buy more focused index funds that drill down into certain parts of the financial markets.
It's a lot less expensive. Index funds are usually far less costly than alternatives like actively managed funds. That's because an index fund manager just has to buy the stocks or other investments in an index -- you don't have to pay them to try to come up with stock picks of their own.
You'll pay less in taxes. Index funds are quite tax-efficient compared with many other investments. For instance, index funds don't have to do as much buying and selling of their holdings as actively managed funds, and so index funds avoid generating capital gains that can add to your tax bill.
It's a lot easier to stick with your investing plan. When you use index funds, you can automatically invest month after month and ignore short-term ups and downs, confident that you'll share in the long-term growth of the market.
Some of the best investment stories of the past 25 years started with investors who recognized the potential of a small-cap stock. Just think of being an early investor in a company like Amazon (NASDAQ:AMZN), which was a $7 stock in 1998, or Tesla (NASDAQ:TSLA), which had a market cap of just over $1 billion in 2010.
Of course, not every small-cap stock becomes a giant. Investing in the stocks of small companies can be very rewarding, but it comes with risks that investors need to understand. Here’s a closer look at what small-cap stocks are, how to choose the best ones, and how to figure out if they’re right for you.
What are small-cap stocks?
Small-cap stocks are stocks of companies with a small market capitalization (the cap in small-cap). We say that a stock is a small-cap stock when the total value of all of the company’s shares outstanding -- meaning the shares held by all shareholders, including company insiders -- falls roughly between $300 million and $2 billion.
Less than $300 million
$300 million to $2 billion
$2 billion to $10 billion
$10 billion to $200 billion
More than $200 billion
Small-cap companies are often young companies: They often have lots of growth potential, but they may also have less stability and market share than larger, established companies.
That’s exactly how it tends to play out with small-cap stocks. The risks may be higher versus larger-cap stocks, but the rewards may also be greater. (Note that the risks can be even greater with micro-cap stocks. Unless you’re a very experienced investor, it’s best to steer clear of stocks with market caps under $300 million.)
Since 2000, small-cap stocks have outperformed large-cap stocks over the long term by 2% per year. But the story is often different over shorter periods (think three to five years or so), because small-cap stocks tend to be more volatile than larger companies, with bigger ups and downs in their prices. Over longer periods, those ups and downs will seem to smooth out.
In 2020, for example, small-caps have vastly underperformed their large-cap counterparts. In the first half of the year, the small-cap Russell 2000 index lost 13.6%, while the large-cap-focused S&P 500 gave up only 4%. Large-cap companies are more likely to be profitable, have ample cash on their balance sheets, and have better access to capital, making them less risky in a crisis like the COVID-19 pandemic. Investors feel safer with large-cap stocks and many likely moved money out of small caps and into large caps during the pandemic. Of course, in a recovery you would expect small-cap stocks to outperform, as these stocks have greater growth potential.
If you’re like most investors, you probably already own some large-cap stocks. These are stocks of companies with a large market capitalization (the cap in large cap). They’re so named because they’re larger than small-cap and mid-cap stocks.
We say that a stock is a large-cap stock when the total value of all of the company’s shares outstanding, meaning the shares held by all shareholders, including company insiders, is greater than $10 billion. (The very largest large-cap companies, with market caps over $200 billion, like Amazon (NASDAQ:AMZN) and JPMorgan Chase (NYSE: JPM), fall into this bracket. Some investors think of them as a separate category of stocks, but for most purposes, they’re just jumbo large caps.)
Large-cap stocks are often thought of as the stalwarts or blue chips of the stock market. Think of companies like Walt Disney (NYSE:DIS), Coca-Cola (NYSE:KO), and General Motors (NYSE:GM) -- long-established giants with dominant positions in their industries.
While many investors find smaller, fast-growing companies particularly exciting, large-cap stocks can be very profitable opportunities for investors who take the time to understand them. And because these mammoth companies tend to be less volatile than their smaller siblings, they can also help diversify a portfolio of smaller stocks while still providing good growth over time. Their principal advantages are that they are safer and more established than smaller companies, usually with reliable profit streams.
However, those assets also mean that large-cap stocks are generally mature companies with moderate growth prospects. Therefore, investors looking for high growth and big potential returns from their stocks may prefer smaller companies or stocks at the low end of the market-cap range.
Here’s a closer look at what large-cap stocks are, how to choose the best ones, and how to decide whether they’re right for your portfolio.
Less than $300 million
$300 million to $2 billion
$2 billion to $10 billion
$10 billion to $200 billion
More than $200 billion
Large-cap companies are typically older and well established, and they usually pay reliable dividends. Not all are household names, but many are. Some large-cap companies are blue chips, meaning they’re very stable businesses with respected management teams, strong credit ratings, and a long history of growth. Others, generally industrial giants, are cyclical, meaning that their profits and stock prices tend to move up and down with the overall economy’s cycles. Some are even fast-growing companies that may have been small-cap or mid-cap companies just a few years ago.
Source: The Motley Fool
Blue Chip Stocks
Blue chip stocks are the stocks of well-known, high-quality companies that are leaders in their industries. These companies have stood the test of time and have gained the respect of their customers and their shareholders. They often make regular and growing dividend payments. With solid business models, blue chip stocks have produced long records of attractive returns, and that's made them among the most popular individual stocks in the stock market for conservative investors looking for places to put their money to work.
Best blue chip stocks
Even if you've never invested before, you'll recognize many of the names of the top blue chip stocks. That's because the products and services that these large-cap stocks provide are part of everyday life for billions of people across the globe. Some of the best blue chip companies you can buy are the following:
Apple (NASDAQ:AAPL) is one of the largest companies in the world, and it's been a pioneer in the technology sector throughout its history. With an array of products from its innovative Macintosh computers in the 1980s and the iPod portable media player in 2001 to its ubiquitous iPhones, iPads, and Apple Watches today, Apple has won a core following of customers around the world who flock to buy its latest products. Apple also earns recurring revenue through its services, which include its groundbreaking iTunes, App Store, and streaming television businesses. Apple's market capitalization climbed above the $1 trillion mark in 2018, and it's still growing.
Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is a major player in the insurance industry, offering various lines of commercial and personal insurance through subsidiaries like GEICO and Gen Re. But Berkshire owns a diverse set of businesses, ranging from Dairy Queen and Fruit of the Loom to railroad giant BNSF and its Berkshire Hathaway Energy utility company. CEO Warren Buffett has amassed one of the most impressive track records of market-beating returns in history, and Berkshire Hathaway has a reputation for safety and security as well as fine performance.
Coca-Cola (NYSE:KO) has been a leader in the beverage industry for more than a century, as its namesake sugary soft drink has spawned a global empire. Yet Coca-Cola has also proven that it can change with the times, and now the beverage leader has a much broader array of products including juices, sports drinks, bottled water, and soft drinks tailored for more health-conscious consumers. Rising dividends also make Coca-Cola stand out, with a streak of consecutive annual dividend payment increases that dates back to the early 1960s and has put it among the top 10 dividend stocks in the market.
Johnson & Johnson (NYSE:JNJ) is well known for its popular consumer products, including baby shampoo, Band-Aids, and Tylenol pain reliever. But J&J is a true healthcare giant, making a wide array of medical devices to help doctors and other medical professionals perform life-saving procedures. Moreover, Johnson & Johnson has a vast pharmaceutical business, producing drugs like the arthritis treatment Remicade, prostate cancer fighter Zytiga, and psoriasis drug Stelara. With its huge scope, Johnson & Johnson makes a difference in the lives of millions of people worldwide.
Walt Disney (NYSE:DIS) has an illustrious history, starting with its namesake creator’s disruptive innovations in the animation industry. Since the early 20th century, Disney has transformed itself into an overarching media and entertainment titan. Its movie studios have made massive acquisitions to become a driving force in Hollywood, but it has also built out its television business, which includes key assets like the ABC broadcast network and the ESPN sports franchise. Disney also has huge exposure to the travel industry, with its theme parks being landmark destinations for many vacationers and its cruise ships helping to introduce Disney fans to the seas. Add to that an extensive network of retail stores, and it's clear how Disney has mastered the art of touching its customers' lives in many different ways.
Investing in blue chip stocks
Blue chip stocks are smart investments for investors of all kinds. Even if you're just starting out with investing, you're likely to be familiar with blue chip companies and the products and services they offer to their customers. Knowing something about the companies whose stocks you're buying makes it more comfortable to be an investor and partial owner of their businesses.
More experienced investors can also appreciate many of the attractive features blue chip stocks offer. The longer you've invested, the more you've seen how blue chip stocks rise to the top over the long haul, outlasting their weaker rivals and finding ways to stay relevant and keep growing even as their industries change.
No matter how long you've invested, if you're a conservative investor, you can appreciate the stability and reliability that blue chip businesses give to their shareholders. Blue chip stocks often hold up better during dramatic downturns than their smaller rivals, and their investors tend to remain more confident about their long-term prospects than less well-established businesses.
If you're looking for maximum growth in your stock investments, you'll want to make sure you go beyond blue chip stocks to look at some up-and-coming small-cap stocks of innovative young companies that are seeking to disrupt their larger rivals. These high-growth upstarts aim to be the blue chip stocks of tomorrow.
However, just about every investor can benefit from having a portion of their portfolio invested in blue chip stocks. It doesn't have to be a set percentage, as different investors will have different viewpoints about how much risk they want to assume. The more you want to preserve and protect the money you have invested in the stock market, however, the more attractive blue chip stocks will be as you try to meet your objectives and reach your long-term financial goals.
Source: The Motley Fool