So, you want to buy some stock. But what kind? And how much? How many shares will you be able to afford? Do you have to buy a certain number of shares, or can you get just a few? How do you know what’s the right type of stock for your portfolio?

The point of investing in the stock market is to find solid stock that is a good value, and that will increase in value over time. Buying stock isn’t too much different than buying anything else. If you try on two pairs of jeans, both of which are of equal quality and fit, but one pair costs $60 and the other pair costs $40, you’d probably conclude that the $40 pair of jeans is a better value.

The same is true with a stock. For all sorts of reasons, stock prices can be all over the place, and some stock is overvalued, which means you’d end up paying more than necessary. In this chapter, you’ll learn about different types of stock, and how some stock might make more sense for you than others. In this chapter, we’re going to consider how to get stock that’s a good value, and that has the potential for good performance down the road.

Chapter 3 included a discussion about personal finance and whether or not it’s a good idea for you to consider investing in the stock market. If you’ve gotten this far, we’re assuming that you have some investment money that isn’t needed for other purposes. With that assumption in mind, let’s look at how much money you’ll need to have to invest in the stock market.

The amount you’ll need to get started depends on how you’re going to invest. If you’re going to use a broker, it will depend on the type of broker you get. You’ll learn a lot more about the role of brokers in Chapter 15, but basically, there are three types—full-service, discount, and online—and they offer different levels of services and fees. Full-service brokers usually require a minimum investment, some as high as $100,000. Others, however, require much less, so if you’re interested in a full-service broker, be sure to inquire about what is required. Discount and online brokers often require a lower minimum investment, and some have no minimum requirement.

Many financial people will recommend that you have a minimum of $1,000 with which to buy stock. Many discount and online brokers, however, require only $500 to start, and some, such as ShareBuilder, have no minimum requirement. However, you may be limited to certain products, such as mutual funds, if you have only a minimum amount to invest. Be sure to do your homework regarding fees before choosing a broker. A broker might require a low minimum opening balance, but charge you if your account goes below a certain level. The fees might not seem like much, but they add up and, when you’re just starting out, can chisel away at your account.

Basically, you’ll need to have as much as the minimum investment requirement if you choose a broker that has one, or you can decide on your own how much you want to invest. Remember that you’ll pay some sort of fee to buy stock, so if you’re planning on buying just a little bit, it might be better to wait until you can buy more at one time. Remember also that you’ll do best in the market if you keep on investing, even if it’s a small amount.

Stock prices are always changing, due to supply and demand. If lots of people want to buy a particular stock, the price goes up because the demand exceeds the supply. On the other hand, if everybody is trying to get rid of a particular stock, the price goes down because the supply exceeds the demand. It’s the same premise as the auction house, where if only one person wants to buy the painting, he’ll get it for less than if 10 people were bidding on it.

It’s important to understand that you can buy stock for $50 a share, or you can buy stock for $2 a share. While $2 a share sounds cheap, it’s not a bargain if the company selling it doesn’t have any earning prospects. If you buy 100 shares of $2 stock from a company that goes bankrupt the next day, you’re out $200. However, if you buy four shares of $50 stock from a company with tremendous earning prospects, your $200 will show you a nice return.

Many brokers aren’t permitted to purchase shares under $5 per share for you, particularly if you are a new investor. That’s because a price that low is often a signal that the company is in distress. So, while price is certainly a consideration when you’re buying stock, you should never buy solely based on price. Most investors use valuation ratios that compare the price of a stock to the results of the company offering it. The most common ratios are:

You’ll learn more in Part 3 about determining the value of a stock. For now, remember that you can only understand the value of a stock if you recognize the value of the company offering it.

For many beginning investors, stock in a company such as Apple is unaffordable. And, as we just mentioned, your decision to buy a stock should never be based solely on price, either low or high. A particular stock isn’t necessarily a good one to buy even if the price is high. Remember that stock is sold at a high price because it’s in high demand. That doesn’t always mean, however, that it’s a good investment.

When a share of a company’s stock is priced at more than $100 or $200 or $500 or $1,000 a share, you would, with good reason, expect that it’s a great company and you’d be very well off to own some of its stock. And often that’s the case. Without doing your homework, however, you could sock every cent of your investment fund into a company experiencing serious problems, despite the fact that its stock was still selling at a high price.

Shares of stock of your regional bank for $20 each could be a great buy, or not. Again, that depends on the strength of the institution. You’ll learn about how to research a company in Part 3 of this book, and it’s important to remember that you should learn about every company, and the industry that company is in, if you plan to buy its stock.

Stock of a company you know can be a good investment, for the very reason that you know the company. You understand how it works, and you can keep an eye on how it’s doing. You’ll know when the bank opens additional branches that it’s growing. Or you’ll know it’s in trouble when you hear your friends complaining about its lousy service, see branches shutting down, or hear that employees are being laid off.

Buying reasonably priced shares of stock of a company that’s poised to take off is what every investor hopes for. The trick is being able to predict what those companies are.

Some people, often those who enjoy trading, like to load up on low-priced stock. Beginning investors who want to own stock but don’t want to risk a lot of money as they learn the ins and outs of the market also sometimes will buy low-priced stocks, which often are referred to as penny stocks.

Understand, however, that penny stocks do not represent all low-priced stock. Penny stocks usually sell on the over the counter (OTC) market, which trades the shares of the smallest and least established companies. They are considered to be a risky investment, and it’s not a good idea to fill up your portfolio with them. Even though you don’t pay a lot for penny stocks, their volatile nature can result in significant losses. Some people swear they’ve become rich from trading penny stocks, but we’d argue that these situations are few and far between.

Low-priced stocks issued by legitimate companies can also be found on the New York Stock Exchange and other major exchanges. If you do your homework, you can find plenty of stocks in your price range, without putting your money greatly in jeopardy.

An example of a low-priced stock at the time this book was written is Wendy’s—the fast-food restaurant that was purchased in 2008 by Triarc Companies, a holding company that at the time of purchase also owned Arby’s. Wendy’s had been having lots of problems since 2002, when its founder, Dave Thomas, died.

Triarc, however, is known for smart decisions in the food industry and for its ability to bring struggling companies back around. And if you watch TV, you’ll know that Wendy’s has a couple of major campaigns going on, including a new line of fancy salads and an offering of $4.99 combo meals. These could be indicators that Wendy’s is turning the corner after a rough time. A little more research would show you that the restaurant chain is on track for meeting financial goals established for the end of 2011, and that it’s sitting on a lot of cash, which is a good thing.

And with Wendy’s stock currently selling at a little less than $5 a share, it’s affordable for lots of investors. This isn’t to say you should run out and buy a bunch of stock in Wendy’s, but it gives you an idea of how, if you’re looking to purchase inexpensive stock, you can minimize your risk by doing your homework and making decisions based on good information, not “hot tips” from friends or the Internet. There’s nothing wrong with owning lots of low-priced stock, as long as you buy it for the right reasons.

As this book was being written, there were about 45 U.S. stocks priced at higher than $100 a share. The highest-priced stock was that of Berkshire Hathaway, priced at $125,000 a share for Class A. For most investors, of course, that’s an impossible buy. And some financial folks will tell you that Berkshire stock can’t possibly go any higher. However, some financial folks said that same thing 20 years ago, when the stock was trading for just under $6,000 a share.

A little bit of high-priced stock can make a nice addition to your investment portfolio, but you should determine that the stock is a good value before buying.

At the time this book was written, Google stock had fallen more than one third from its all-time high. So, you might figure, the company is a losing proposition because its growth has slowed and stock values decreased. A bit more research, however, will show you that Google is on track to expand in several areas, including increasing its advertising revenues and launching a tablet computer to compete with Apple’s iPad. Some analysts predict that Google’s stock will be back up over $700 per share in the next 12 months. If that’s so, the current $550 price per share looks very attractive. You should note, however, that expectations are extremely high for companies like Apple and Google, and investors sometimes turn on them if they don’t perform as well as investors feel they should. If that happens, it could result in a sell-off, meaning that stock values would drop.

If you don’t have much money to begin investing with, very high-priced stocks probably will be out of your price range. Remember that even $10,000 is considered small potatoes when it comes to stock investing. And even with that amount, you’d probably have to purchase in odd lots, which is fewer than 100 shares of stock, because you don’t want to put all your money into one stock. One hundred or more shares of stock is called a round lot.

There’s nothing wrong with buying odd lots of stock. The trick is to make sure you have enough money to properly diversify your stock purchases. If you’re buying expensive stock with a little bit of money, you might not be able to do that. In that case, it’s better to buy a more diversified collection of less expensive stock (which you’ve carefully researched and approved, of course) or invest in a mutual fund, which invests your money in a diversified group of securities.

Stocks can be divided into two categories: growth stocks and value stocks. As you know, there are other kinds of stocks as well, but for now let’s consider these two kinds, and the reasons that investors buy them.

Some people consider growth stocks and value stocks to be completely different animals, but actually, there can be a lot of overlap. Growth stocks can actually morph into value stocks, as we’ve seen with pharmaceutical companies. Conversely, value stocks can become the new growth stocks, as we’ve seen recently with companies that deal in commodities, such as oil companies. Generally, growth investors look at how fast a company has been growing instead of how closely the price of its stock reflects the company’s value. Value investors use fundamental analysis to identify stocks that are undervalued.

The trick, then, is to find growth stocks in companies that are strong and have qualities that will help them to continue to grow and assure that the price of stock will reflect the value of the company. Let’s have a closer look at these two types of stocks.

A growth stock is the stock of a firm that’s expected to experience increases that are higher than average in revenue and earnings. These firms tend to retain most of their earnings for reinvestment (research and development within the firm), meaning they don’t pay dividends, or pay small dividends.

Growth stocks often sell at relatively high P/E ratios, and are subject to wide swings in pricing. Investors who buy growth stocks generally are looking for capital appreciation and long-term capital growth. Growth stock is considered to be more volatile than value stock, but it has a better chance for growth in the short term. Examples of growth stocks include Lowes, eBay, and Starbucks.

A value stock is a stock with a price that’s considered below normal, based on valuation measures common to the market. An investor will look at the underlying financial health of the company, and, using tools such as P/E ratios, return on equity, growth perspectives, and other factors, make a determination concerning the valuation of the stock.

Investors who buy value stock tend to hang on to it for relatively long periods of time, and believe it will result in returns down the road. It might take a while for a value stock to be recognized as such, meaning that your investment may take time to increase in value. Historically, however, a value stock carries less risk than a growth stock and its growth tends to continue for a longer time. Examples of value stocks include McDonald’s, Proctor & Gamble, and Verizon.

Whether you buy growth stock, value stock, or a combination of the two, depends on your investment style, which considers factors such as your time frame, risk tolerance, and how much time you plan to invest in your investments. Most financial types would recommend that your portfolio contain both growth and value stocks, as it’s important for diversification, as you read in Chapter 5, and will learn much more about in Chapter 10.

Income investing is when you buy stock that has a relatively high dividend yield, a major consideration for older investors. That’s called income stock, and it typically is that of a firm that has stable earnings and dividends and operates in a mature industry. Critics of income investing say it’s defensive investing and too conservative, but defensive and conservative no doubt sound great to an older investor who receives dividend income to supplement Social Security and any other income.

Income investing is recommended for investors who are looking for security. Historically, income stocks have outperformed other investments over time, and with less price fluctuation. Income investing is particularly effective when dividends are reinvested. Income investing isn’t flashy or exciting like growth investing, but there’s probably a place for it in your portfolio.

Just remember that income stock, like any stock, is subject to the ups and downs of the market, and there are no guarantees that you’ll end up receiving big dividends. Also, income stocks can be affected by rising interest rates because investors tend to move into other types of investments, causing the prices for income stocks to fall.

You learned in Chapter 1 that dividends are payments companies make to investors who hold shares of their common stock. Dividends occur because these very large and established firms are no longer rapidly growing and expanding, meaning they don’t need to reinvest as much of their earnings back into themselves. The earnings that aren’t being plowed back into the company can be divided up among shareholders instead, as a means of providing a return on their investments.

Companies within certain industries are more likely to pay out dividends to shareholders than those in other industries. Utility companies, energy sectors, and financial institutions have traditionally, although not always, come through with dividends. Of course, many financial institutions were hard hit by the recession that started in 2008, affecting their ability to reward investors, and companies within other industries were forced to decrease dividends as well.

Dividends generally are paid four times a year. For an investor to receive this dividend, you have to own the shares on the record date. For instance, J.P. Morgan’s dividend was declared on September 9 to owners of stock held on October 6. If you bought shares on October 7, you would have missed the dividend. If you bought the shares on October 5, you would have received the dividend. When you buy is important if the company pays a healthy dividend.

Johnson & Johnson is a good example of a company that pays dividends to stockholders. In fact, Johnson & Johnson increased the rate of its dividend payment every year for more than 40 years, beginning in the 1960s. The dividend yield on an initial investment grew by about 12 percent annually, resulting in great annual returns.

Income from stocks sounds great, but it isn’t just about locating companies that pay the highest dividends and buying their stock. As when purchasing any type of stock, you’d want to make sure the company offering it is sound. And you should consider the dividend yield, which you get by dividing the total annual dividend per share by the price of a share. That number reveals what percentage of the stock’s current market price the dividend represents, and allows you to see how it stacks up against the average dividend yield.

The average dividend yield for companies within the Standard & Poor’s (S&P) 500 is between 2 and 3 percent, but most investors look for companies with higher yields. You can find out what sort of dividends a company pays by visiting the Yahoo! Finance website (http://finance.yahoo.com) or other financial websites (see Appendix B). The last declared dividend amount and the yield are usually listed near the current price of stock.

When looking to identify income stocks, you should also look at the underlying company’s past dividend policy. If there’s just been a big increase in dividends, analyze whether the company may have been overly generous and likely to find out it can’t continue distributing dividends at that rate.

Remember that the longer a company’s been paying out dividends, the more likely it is to continue doing so. Look for those that have been doing so for at least five years, and check to see which companies offer dividend reinvestment plans (DRIPs), which allow you to reinvest dividends to buy additional shares of the company’s stock.

Also, if a dividend yield is too good to be true, check out the recent performance of the stock. Ten percent is too high in today’s economy, so if a stock is paying a 10 percent dividend, it most likely recently plummeted in value. Dividends, unfortunately, can be cut.

Picking income stocks entails the same degree of methodical analysis as picking any other type of stock, and you should never invest solely because you’d get dividends. Although many reliable, well-established companies pay out dividends, the payment of dividends does not automatically mean that a company is a good one.

A few companies that experts have recommended as good income investments are listed in the following table. Remember that the list, which includes the company’s name, website, exchange on which it’s listed, and its ticker symbol, is just suggestions of companies you can research in order to draw your own conclusion as to whether it’s a good investment.

Some investors invest in particular industries or buy stock from companies because they like what they stand for. Conversely, some investors won’t invest in companies because they don’t like what they stand for. This broad-based approach to investing, often referred to as socially responsible investing, has been in play for years, as groups have either supported or rejected certain industries or businesses. Investors who engage in socially responsible investing typically are concerned with environmental factors, social justice, and corporate governance.

Investing in companies associated with the green industry is attracting a lot of attention from socially responsible investors. They are looking to invest in companies involved in improving environmental conditions, lessening environmental impact, and providing new technologies in the areas of alternative and renewable energy. Some of these same socially responsible investors are boycotting investment in BP in light of the massive oil spill in the Gulf of Mexico in 2010. Over the years, socially responsible investors have balked at investing in companies that manufacture guns, cigarettes, war materials, alcohol, and baby formula exported to poor countries where it would be diluted and misused.

Whether or not you’re interested in socially responsible investing is entirely up to you. Remember, though, that while standing up for social causes is necessary and admirable, to do so at risk of your financial future isn’t responsible. Make sure you conduct the same research you would with any other sort of investment, and never invest in a company just because you’re admiring of its purpose or product.

The Least You Need to Know