Stock Market Basics: Value to the Shareholders

Yesterday, my heart was palpitating as I watched my Patriots take on its NFC nemesis, the NY Giants. That match up has history that doesn't lend itself in the Patriots favor, but yesterday the Patriots won 27-26 on the foot of the great Steve Gostkowski.

The hardest question for a Pats fan to field over the last 8 years was 'why cant the Patriots beat the Giants?' That question is the equivalent of 'what is the stock market?' to an investment adviser. An emphatic, cut and dry answer still alludes us to this day.

To say that I can try explain to you what the stock market is in its entirety in one post would be a disservice to all that goes on in the market. But primarily what you need to know is that the stock market is the virtual world in which equities (or stocks) are traded.

Companies offer themselves to the public in part or as a whole on the stock market in the form of equities. Equities are then broken down into shares. Shares are the portions of equities that we as investors can buy on the stock market. So basically shares are pieces of a company that shareholders own. By owning a piece of a company, you've decided to allow the company to use your money to grow, build value and/or  generate income for you.

Ever heard of return on equity?

The return on equity is a measure of how well a company uses the money that you as a shareholder provide by buying shares of it. When looking for good growth companies, you want to see the company generate more revenue, cut on expenses and run efficiently so that it generates a high rate of return on equity on an annual basis. When looking for good value companies, you're looking for companies that have a stable value but may be under priced for periods of time due to a market correction (like we experienced in late August to the beginning of October), changing leadership or an acquisition/merger. If you are looking for income-generating companies, companies that pay dividends to their shareholders are definitely the target.

This post only covers one way to categorize equities (or pieces of companies available to the public) by the value they generate to the shareholders. Whether a company is a growth company, value company or income-generating can be a fluctuating metric and hard to really pin down, but still an important decision when looking to invest in companies. Here are some good key ways to tell which of the three categories a stock falls under:

So those three categories again are growth, value and income-generating. Fortunately, those categories don't have to be mutually exclusive. There are several great value stocks that are also income-generating stocks because not only are they sometime below fair price, but they pay hefty dividends and consistently make their revenue and net income targets.The growth/income-generating and growth/value combinations are a powerful combo because not only can the company create revenue for itself while innovating new products or services, they pay out dividends to their shareholders.

Companies like Apple and Amazon are companies that cross the growth/income generating lines.

Cognizant and Monsanto are examples of middle of the road companies between growth and value.

Examples of value/income generating companies include Pfizer and Cisco Systems.

The next post we will discuss how to categorize a company more objectively by the dollar value of the company that is traded on the market.