Stock Investment Guide for Investors

The purchase of stock is an equity investment in a share of the ownership of a business entity. Purchasing stock gives the owner right to participate in the future earnings of a business. Most widely traded stock is limited liability, meaning that although the investor may participate in future earnings of the business, they are not responsible for losses of the business. Investors need to consider a number of factors when purchasing stock.

Allocation

• The first thing an investor looking to invest in stock needs to consider is the amount of the investor's total portfolio that should be allocated to stock purchases. Investment allocation involves distributing an investment portfolio amongst different asset categories, such as stocks, bonds, and cash or equivalents. Many stocks are risky investments, while cash equivalent investments are relatively safe. The trade-off, however, is that, over the long-term, investors expect stocks to generate a greater return than cash equivalent investments will. Investors much decide how much risk they can tolerate and how much of the investment portfolio should be allocated to each asset class.

Diversification

• Once an investor has decided how much to allocate to the purchase of stocks, the investor should consider portfolio diversification. Portfolio diversification allows the investor to reduce the risk associated with investing in a particular company while maintaining the level of expected return. Investors should consider not only investing in different companies, but also companies in different industries. Many investors purchase mutual funds or exchange traded funds which allows the investor to instantly diversify a stock portfolio.

Fundamental Analysis

• Investors look at a number of different factors when determining which stocks to purchase. Many investors use fundamental analysis techniques involve examining stock price data and company financial statements to make investment decisions. Some investors look for "value" companies, where they believe the company's market price is below company's the intrinsic value. Investors looking to identify value companies may look at the price to earnings ratio or book value of the company. Other investors use fundamental analysis to try to identify growth companies, that are likely to have high future earnings.

Dividends

• Dividends are distributions of earnings paid to stockholders. Dividends are optional and are declared by a company's Board of Directors. Dividends are optional. Many companies do not pay dividends during periods when earnings are low and many smaller, expanding companies have never paid dividends. Most companies which pay dividends do so on a quarterly basis. Investors purchasing companies that pay high dividends are often called income investors.

Tax Implications

• Stock investments generally generate two types of income upon which investors must pay tax. The first results from the periodic dividends of the company and the second relates to the capital appreciation or loss resulting from fluctuations in the market value of the company's stock. In the United States, the Internal Revenue Code allows special, reduced tax rates on many dividends and on capital gains from stocks held for more than one year.