Stocks are investments that give you a share in a company and, as a result, a certain right on its assets. This may prompt you to wonder why companies would want to split their profits. The answer is simple: financing (that is, to raise funds and continue growing).
Companies have access to two types of financing:
- They can borrow from a bank or issue bonds but by doing so, they have a loan to repay; or
- They can issue stocks, i.e., sell shares to investors. This allows the company to raise funds without being burdened with debt.
Generally, companies issue stocks through an initial public offering (IPO). If the company needs additional funds, it will issue additional shares through another public offering. Once all the shares have been sold to investors, they can be traded on the secondary market, such as the stock market.
Stock market trades take place between investors, and the company no longer participates in these transactions. The price of a stock is essentially determined by supply and demand, which means that the more buyers there are, the higher the price of the stock will be.
In theory, investors want to purchase stocks whose value will increase over time, therefore driving demand for it. There are numerous reasons that can explain the demand for a stock, one of the most important being the company’s ability to grow its profits. Remember: as a shareholder, you are entitled to part of the profits, which means the higher the company’s net revenue, the higher the value of the underlying stock.
Finding a stock’s market value
The value of exchange-traded stocks is usually published in newspapers (finance section), on the Internet (for instance, on brokerage firms’ websites), or on your smartphone applications.
Here is an example of the National Bank of Canada stock, as shown on the National Bank Direct Brokerage website:
In this example, the stock is trading at $75.13. This means that the last trade of this stock was executed at that price. To the right of that number, you can see the variation (here, an increase of $1.06 or 0.0799%) since the opening of markets that day. Finally, you can see the trade volume of 231,657, which represents the number of National Bank stocks traded since the opening on that particular day.
Below these, you will find detailed information about the company, such as the opening price, the high (day and year) and the low (day and year).
The most important information for your trade is the bid/ask price. If you want to purchase this stock, you must pay the ask price; if you want to sell them, you will obtain the bid price. The quote that is shown here ($75.13) is therefore not necessarily the price you will receive (or pay).
The different types of stocks
There are two main types of stocks: common shares and preferred shares.
A preferred share is a stock that yields a regular, fixed amount taken from the company’s profits. This amount is known as a dividend. Preferred shares give you priority over common shareholders when it comes to dividend payments.
The characteristics of preferred shares are very similar to that of bonds, as they constitute a loan made by the investor to the company. This loan can be redeemed at the discretion of the issuer, allowing the company to buy back the shares at any time, at a fixed price; or they can be redeemed at the discretion of the shareholder, thus allowing you to redeem the shares to the company at a specific price and at precise moments.
Some preferred shares are convertible, which means they can be converted into common shares.
The following table highlights the main differences between common and preferred shares:
|Company has no obligation to pay dividends
After preferred shareholders
Potential for capital appreciation
|Dividend is usually predetermined and distributed before common dividends
Between creditors and common shareholders
Market value more stable than common shares; fluctuates like fixed-income securities
Voting right is an important differentiator of common shares. Common shareholders can exercise their voting right at annual, general or extraordinary meetings. They can elect directors to manage and control the company’s activities. Conversely, preferred shares do not usually provide the right to vote.
The ability to receive dividends is another important feature of stocks. The company may choose to pay out dividends, to reinvest them in the company, or to combine both by distributing part of the profits to shareholders and reinvesting the balance in the company.
In the event of bankruptcy, stocks hold a relatively low position on assets; shareholders may lose all of their investment to creditors, bondholders and debenture owners. Assets will indeed be distributed to these investors before they, if there are more funds, are distributed to preferred shareholders and then, common shareholders.
The benefits of stocks
If stocks seem riskier than fixed income securities or other, less volatile investments, they remain an asset class that offers the highest return potential over time. Indeed, because the sale proceeds of stocks are paid out to shareholders (the issuing company has no right on these proceeds), capital appreciation remains its most attractive feature. In other words, as long as a stock’s value increases, shareholders do not lose their initial investment and have the opportunity to make a profit on the sale, especially if the shares are kept over a long period.
Furthermore, some stocks can pay dividends and generate capital gains. These sources of income benefit from a very advantageous tax rate in Canada; dividends provide a tax credit, while capital gains are only taxed at 50%. This fiscal edge can serve to increase your return over time.
Risks associated with stocks
Stocks are typically considered risky investments because of their volatility and the fact that if the underlying company declares bankruptcy, you could lose all of your investment. Preferred shares entitle you to a specific amount if the company was to close its doors, but you would only get paid once all bondholders and other creditors have received their share of the assets, which could affect the amount that is distributed.
It is important to understand that some stocks carry more risk than others. Small companies that do not pay dividends and have yet to demonstrate the sustainability of their growth over time are often the riskiest. That is in fact why they offer you a higher return potential.
Larger, well-established companies that have shown a certain level of growth over time and that have a solid track record of paying dividends are usually less risky. But this also means that their return potential is often inferior to that of smaller companies.
These investments are considered volatile because their value can vary considerably over the short term. If you invest in stocks and suddenly find yourself in need of that investment amount, the value of your stocks may have dropped and you could find yourself at a loss. It is because of this characteristic that many advisors will recommend you reduce the proportion of stocks in your portfolio as you near your financial objective. For instance, it is rarely advised for a pre-retiree to invest a large amount in stocks. It is best to choose safe products that are easier to liquidate.
Another element that is more specific to preferred shares is interest rate variations, which can affect your return. If interest rates rise at a time when you are looking to liquidate your shares, you could receive less than the amount you had initially paid for them.
Finally, there is a risk associated with dividends. A company may reach a point where it no longer has the means to pay out dividends. In this event, you could be forced to sell your shares at a loss since other investors will no longer see the value in paying a certain amount for this stock.
Finding the right stock for your situation
Stocks are by far the investment of choice when it comes to diversifying your portfolio. But that does not mean that you should buy any stock that is trading at a good price. You must find those that match your investor profile and your investment objectives over time.
To do so, it is possible to use filters to build a list of stocks that match your criteria. You could, for instance, use a filter to find companies that offer dividend-paying stocks. This filter is integrated to your National Bank Direct Brokerage account, under Quotes and Markets – Stocks.
*Note that the stock symbol of a preferred share always ends with “.PR”. For instance, the National Bank of Canada preferred share symbol would be NA.PR.
Borrowing to purchase stocks
You can request a loan to purchase stocks. Usually, this is done through a margin account.
With your National Bank Direct Brokerage account, it is easy to trade stocks online.
- First, click on Transactions - Stocks and a transaction page will open.
- Then, select the transaction you wish to carry out (buy or sell) and indicate:
Then click “Submit”.
- The number of stocks (not the amount you’re investing)
- The stock symbol (e.g., BBD.PR.B for Bombardier’s B-Series preferred shares)
- The stock market (Canadian or American)
- The price (limit or market price)
- The expiry (if limit price) and restriction
Verify the information to make sure you haven’t made any mistake, and click “Confirm”.
Once your order has been submitted, you may view it under Transactions – Current Orders and Instructions.