Why Do Investors Buy Stocks?
Stocks are units of ownership in a corporation. If you bought 1,000 shares of a company that has 5,000 shares, you would own one-fifth of the business and be entitled to proportional proceeds from the money the company makes. From the corporation point of view, stocks are issued and sold to raise funds for activities such as expansion. When investors buy the stock, corporations are essentially selling units of ownership for additional funds.
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Trading
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When a corporation decides to sell stocks, it does so in the primary market, in the form of an initial public offering, or IPO. After all the shares of the particular company stock are bought by investors, the stock is traded in the secondary market, such as the New York Stock Exchange. Investors who purchase stock in the primary market may decide to sell the stock to other investors in the secondary market. When you place an order to buy 100 shares of a corporation's stock through a broker, you are participating in the secondary market.
Capital Gains
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One of the main reasons investors buy stocks is to earn a return on the investment, known as capital gains. If an investor buys 50 shares of stock for $10 per share, it would cost him $500 for the shares, plus a specified flat fee paid to the broker for conducting the transaction. With, for example, a broker's fee of $10, the cost of the shares $510. Subsequently, if the price of the stock rises to $15, the investor could sell all his shares for $750 and realize a profit---or capital gain---of $240 ($750 minus $510).
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Risk/Return Tradeoff
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Risk and return are important considerations in making investment decisions. Generally, an investor will only buy a "risky" stock if the potential returns are substantial. Suppose an established business, Company A, and a new business, Company B, both had stocks selling at $10. Because Company A is a safer investment due to a performance history and Company B is a riskier investment, investors might be willing to buy Company B stock only when its expected returns are much greater those of Company A. Understandably, new company stocks are more volatile and may rapidly lose or gain in value, depending on growth or failure.
Dividends
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Investors may buy stocks to receive dividends, which are disbursements of profits made to stockholders. If you own 100 shares of a company that has 1,000 shares, you will own one-tenth of the business and be entitled to one-tenth of its profits. If the business earned $5,000 over a period, then you would receive a dividend of $500 (one-tenth of $5,000). If a corporation sustains losses over a period, then as part owner, you would have to bear a proportional part of the loss and not receive any dividend for the loss period.
Managing Power
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Less common reasons investors buy stocks is to have influencing power over the corporation or to simply own a part of a company that they like. Since corporations may have millions of shares in the market, gaining some level of power entails making a significant investment in a single company, which is beyond the scope of most investors.
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References
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