Over the last few years, and especially since the COVID-19 pandemic, a lot of Canadians have become do-it-yourself investors. A number of trading apps have made it easy for anyone with a phone to buy and sell stocks, while an explosion of online tools and analysis has now made it possible to perform high quality research on your investments. But the stock market can be unforgiving if you don’t know how it works. It’s easy to lose money, deviate from an investment plan and get lost in a sea of data.
At the same time, you don’t need to be a trained economist to invest and grow your wealth. People of all ages, backgrounds, income brackets and financial savviness have put money away to save for retirement and other important goals. To begin, you should understand how the market operates. We’re going to help you do that.
What is the stock market?
Like farmers markets or flea markets, stock markets are spaces where buyers and sellers gather to trade. Though in this case it’s not vegetables or old typewriters, but rather shares of companies that are listed on a public stock exchange. In the past, traders, acting on behalf of buyers and sellers, would gather on a physical trading floor to execute transactions. This is why many stock markets are named for the city where they’re based, like the Toronto Stock Exchange or the New York Stock Exchange. Now, though, most stock markets operate primarily on digital platforms, where the transactions are largely automated.
It’s important to know that not all kinds of company shares can be traded on a stock exchange. If a company is private, then a smaller group of people — maybe it’s a family or the business owner and a few other investors — own all the shares in the company. It’s far more complicated to sell those shares privately than it is on a stock exchange. There can come a point when a company gets big enough, and has enough private shareholders, that it decides to “go public.”
When that happens, those stockholders can sell their shares to the public on an exchange with the hopes of making a return off their initial investment.
Who gets to list on an exchange?
Not every company can list on an exchange, though it’s not just big businesses that choose to go public. Some exchanges cater to smaller operations, including companies that don’t generate profits and may only have, say, $500,000 in revenue. Larger operations will generally list on the more popular stock exchanges which get far more investor attention — the largest of which is the New York Stock Exchange (NYSE). It usually costs the company money to get listed on an exchange — anywhere between $10,000 and $200,000 for the Toronto Stock Exchange — and then a lot more to handle the obligations that come with being a public operation.
For instance, to ensure a level playing field for investors, regulators and the exchanges themselves impose numerous rules on public companies. They must publish financial statements (usually every three months). They must hold annual meetings where a board of directors is elected or affirmed to represent shareholder interests. (The board serves as the boss that the company’s chief executive officer reports to.) Company insiders — management, directors and major shareholders — are forbidden from trading stock in the company if they know key information that has not been publicly disclosed to all shareholders. There are other rules to follow, too.
How the price of a stock is determined
The terms stocks, shares and equities are used interchangeably. They all refer to portions of the company’s overall equity. If you add up the value of all the company’s shares in circulation, you get what’s called shareholder equity or market capitalization. You can also think of it this way: If a company has a $3-billion market cap, then that’s what it would cost to buy every share and take the company private again.
Of course, that number could change. Share prices fluctuate depending on how much money someone wants to buy the shares for and how much someone is willing to sell them at. However, buyers and sellers aren’t picking the price out of thin air. It’s based on what’s called fundamentals — numbers that come from the company’s own financial statements. Your broker or investing app will readily list a few of them when you look up the stock. Typical information might include earnings growth, revenue increases, debt owing, companies that pay dividends and more. TD Direct Investing’s platform, for instance, lists all kinds of fundamental data investors can use to make decisions about their portfolios including research from analysts. Not all companies and industries are the same, though — businesses in some sectors grow more slowly than others, while companies in certain industries are OK with holding a lot of debt.
If a piece of news comes out that hurts the profit expectations of the stock or its sector, or if any of the company’s numbers fall short, prospective buyers may lower their “bid” price — the level at which they are willing to buy the stock. If the news is positive, existing shareholders may raise their “ask” price — the price at which they’re willing to sell their shares — and the stock goes up.
What do you get for being a shareholder?
In the old days when you bought a share, you received a paper certificate. Today it’s recorded simply as a digit in your brokerage account that you see on your computer screen or on your statement. However, that registered ownership still entitles you to vote on major company decisions — such as who joins the board of directors — in person, by proxy, by mail or digitally, in advance. You will be notified of company meetings and special resolutions.
Your share only ceases to have value if the company goes bankrupt. When insolvency looms, there is a pecking order that determines the sequence in which stakeholders get paid. First come employees and the taxman, then secured creditors, followed by unsecured creditors including suppliers and bondholders. Generally speaking, shareholders come last, which is why stocks are considered to have a higher risk than most investable asset classes.
How do I make money from the market?
The return you earn from stocks comes in two forms: capital gains and dividends. A capital gain is the amount the stock price rises over time. (Of course, stocks can also fall, producing a capital loss.) If you buy a stock, and the price goes up, you have an unrealized gain. It’s only once you sell it that you get money for holding that share.
Dividends are payments that companies make periodically to their shareholders out of their profits. This happens most often with larger, more mature companies. For example, a company might pay its shareholders $0.10 every quarter, or $0.40 a year, for every share they own. (It goes straight into the investor’s brokerage account.) If that company’s stock trades for $10 a share, we say it has a dividend yield of 4%.
Say the same stock rises in price to $10.50 by the end of the year. Its total return for that year — capital gain plus dividend — is 9%. (That does not include any additional costs or transaction fees.) That can be more than what a government bond or guaranteed investment certificate will give you, even though those debt instruments are less risky. (This is where the term risk and reward comes in — generally, riskier stocks can have higher potential rewards.)
Different investors take different approaches to seeking to make money in the stock market, depending on their investment philosophy. Some focus on active trading, trying to anticipate market moves and take advantage of price changes day to day. To do this successfully and with any consistency is extremely hard to do. As an individual investor, you can virtually guarantee there will be other players in the marketplace who may have more investment knowledge or have more data and money at their disposal than you. It’s one reason why many investors may employ a “buy and hold” strategy, which is when they own stocks that they hope will increase in value for years at a time.
Where you can buy stocks?
You may be exposed to the stock market without necessarily knowing it. When you contribute to the Canada Pension Plan, for example, part of those deductions from your paycheque ultimately gets invested in stocks. Your employer may offer its own pension or Registered Retirement Savings Plan (RRSP), including equity funds or an employee share ownership plan for its own stock. You may have money invested in mutual funds that are partially allocated to stocks. If you’re a postsecondary student, you may be drawing funds from a Registered Education Savings Plan (RESP) set up by your parents, which likely has some of its funds in the stock market.
These are all perfectly valid ways to use stocks to grow your wealth. But if you want to participate in the stock market directly, that’s easy, too. The first step is to set up an account with a broker, such as TD Direct Investing. Once upon a time, a broker would have been a person who worked in a stock brokerage, and who made trade orders on your behalf and provided advice around building a portfolio. Nowadays most self-directed investors opt for an online or “discount” brokerage that holds your investments and executes your trades but provides only investor education and market data, not advice.
Most banks and credit unions offer such services, along with dedicated online brokerages. Typically, there is no cost to set up an account and a single trade will cost $10 or less. A few brokerages, including TD Direct Investing, offer some commission-free investments. TD GoalAssist, for example, requires no minimums to start investing, no monthly fees and there is $0 commissions when you trade TD ETFs.
How people pick stocks
When it comes to picking individual stocks, there are a few strategies and approaches to consider.
1. Consider the fundamentals
It can be important to look at the fundamentals, such as earnings growth, revenues, free cash flow, year-over-year sales increases and more to help ensure the companies you’re buying are making money or have the potential to grow. You may encounter operations with soaring share prices and no revenues (common among technology companies), which may be doing well because investors think they’ll make money in the future. (That is a risk: At some point investors may not want to wait for profits and could start selling.) When it comes down to it, stock prices increase when company earnings rise, so be confident that the businesses you are looking to invest in will do well over time.
When you’re picking stocks, think of yourself as a fund manager. No manager picks one stock, because if that company falls apart so might your savings. Rather, consider buying several stocks across industries and geographies. This strategy is called diversification and can help protect you from a bad buy — if one business goes belly up, then you have a bunch more that may keep your portfolio afloat. The chances of all your stocks going bankrupt is unlikely.
3. Buy what you know
With thousands of stocks to choose from across the globe, where do you even start? One possible approach, which many professional fund managers follow, is to buy companies you know and whose products you love. Chances are a lot of other people feel the same way, which may bode well for the stock’s future. If a company is familiar, then you’ll have a much better grasp to how it operates, what it sells, if it’s doing well and more. That can make it easier to understand the fundamentals and make an informed decision on whether to buy it or not.
4. Use your discount brokerage’s tools
The actual act of buying and selling stocks isn’t difficult — it’s all supported by your discount brokerage’s website or app. Essentially, you can find the business you want to buy, decide how much money you want to spend on it and make a purchase. Again, diversification is important to consider: You might consider purchasing a similar dollar amount of each stock in your portfolio. Make use of the tools within your brokerage’s app or site, too. Most have stock screeners, which can help people figure out what to buy, as they allow you to sort companies by various metrics, like revenues, earnings, or dividend yield to compare operations.
However you invest, getting experience in the stock market early may make it easier for you to work toward your financial goals, such as saving for retirement or getting your kids through university or college. While the tools and platforms you use to invest will evolve, companies have been selling shares since the Middle Ages, and stock markets have existed almost as long. Take it slow, follow the fundamentals and you may just find your confidence growing.