The stock market can be confusing. Most of the time we just start investing, knowing that it’s what we’re supposed to do to grow our money, but we rarely take time to understand what it really means to own a stock.
In this article, I’ll give you a breakdown of the stock market and why we use it as a vehicle to grow our investments. Having a better understanding of this, as well as reasons behind why you’re investing, will make you a better investor in the long run.
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What is the stock market?
A stock market is a market system where shares of a publicly-traded company are traded back and forth. Owning a share of a company is like owning a small piece of the company itself, and it allows people to participate in the overall success (or sometimes failure) of a company through dividends, profits, and losses.
Stocks are traded through stock exchanges. The two biggest stock exchanges are the New York Stock Exchange (NYSE) and Nasdaq (NASDAQ), founded in 1792 and 1971, respectively.
Back in the day, when you bought or sold a stock, you were issued a physical paper certificate stating that you owned a share (or small percentage) of the company. Today, this is all done electronically.
The stock market really has two sub-markets-the primary market and the secondary market. The primary market is when a company decides to go public for the purpose of raising capital(cash, that is), and issues an Initial Public Offering, or IPO. Large investment firms will get the first crack at buying the stock, which they do through the primary market. Once the majority, or all, of the initial shares are purchased, those investment firms will re-sell the stocks on the secondary market-commonly referred to as the open market or the equity market. When you go to buy a stock through your favorite online broker, for example, you’re buying it through the secondary market.
Why do companies want to go public?
Publicly owned companies are a huge part of our economy, playing a major role in not only basic capitalism, but also our savings and retirement system. Without the ability to invest in other companies, there’d be no stock market, and thus no major platform for us to grow our savings that lead to retirement. We’d have to take our changes on things like real estate and art.
“Going public” is a way for growing companies to grow even bigger, and do it much faster. By “going public,” the company is allowing others to own part, or all, of the company. In exchange, the company gets funding to grow (money).
Think about it like the show Shark Tank, only the small business people are the company, and the investors are the large institutional investment firms. They’re giving the company money in exchange for part-ownership of the company. It’s obviously far more complex than that, but that explains the basic reason a company would want to go public-for growth.
What does it mean to own stock?
Owning stock in a company, or owning shares of a company, means you own a piece of that company. Now before you start jumping up and down thinking you get to slap on a suit and walk into the corporate headquarters to boss everyone around, remember how much of the company you actually own. Odds are it’s very, very little and you have essentially no power. Sorry to break it to you.
Think about it this way. Apple (AAPL) has 5.247 billion outstanding shares available for trade. Say you wanted to invest $10,000 in Apple today. At the time of this writing, Apple’s stock price was $129.08. With $10,000, not including any brokerage fees, you’d end up with approximately 77 shares of Apple stock. Congratulations, you own part of Apple.
Remember when I told you they have 5.247 billion outstanding shares? Take your 77 shares and divide it by 5.247 billion:
77 / 5.247 billion=.000000014675 percent
As you can see, you own a fractional amount of the company, so you won’t have much say in how they do things.
The reason I did that is so you can switch your focus on what it means to own a stock. While you own a portion of the company, it’s a minuscule portion. The greater benefit, though, is that you now get to have a claim on the company’s assets and earnings.
This means that as the company makes money, they may issue dividends-or pieces of the profit-to its shareholders. The more stock you own, the more you’ll make on dividends. If the company is acquired or goes bankrupt and liquidates its assets, guess who gets the benefit? The owners do. Now, if your company goes bankrupt, they’ll have to pay all their creditors first before you get anything, so being acquired is a much more fruitful investment (obviously).
By owning stock and owning part of the company, you get to benefit from the success of that company. And if you’re a great investor, you benefit from the fear of other investors when they sell their shares in a panic.
More on dividends
A dividend is a dollar amount that some companies choose to issue to its shareholders as a form of return on their investment. It’s correlated to their overall earnings, and you’ll see the dividend currently offered by a company by looking at its Earnings Per Share, or EPS.
Not all companies issue dividends, though, and that doesn’t make them a poor company. Some companies, often newer companies or companies that are in a fast-growth industry like technology, will choose not to issue dividends and instead reinvest that money into their company.
While it’s not always the case, the argument here is that with a dividend-paying stock, you’ll get smaller overall returns, but get a dividend, and with a company that’s growing at lightning speed, you won’t get a dividend but you can expect higher returns. Again, that’s not always the case and you definitely shouldn’t base your investment strategy on it, but it’s a common argument.
Dividends are not guaranteed; companies can stop issuing them at any time. They’re typically issued quarterly and are a key part of the Value Investing Strategy.
What causes stock prices (and markets) to fluctuate?
What’s interesting about stock prices is their ups and downs don’t necessarily directly correlate to the company’s overall performance. Meaning, if a company is doing poorly financially or bombs on its latest product, that in and of itself doesn’t cause the stock price to drop.
Remember, we’re all owners of the company. There are a ton of factors that determine the price of a stock, and it’s often our reaction to those factors that cause the price to move.
For example, if you own stock in Apple and see that their CEO is being indicted on multiple counts of fraud, you’re probably going to panic. While this may ultimately end in Apple’s demise, the ultimate drop in the stock price is caused by your fellow panicked owners, who all suddenly want to sell their stock.
When there are more sellers than buyers, the stock price will fall. It’s basic economics. If you were selling apples at a farmers market and there were 100 other people selling the exact same apples as you, you couldn’t exactly put a premium price on those apples. You’d have to drop the price significantly to attract a buyer. It’s the same thing with stocks.
Other factors like news, natural disasters, poor financial performance, acquisitions, (and the list goes on) can all impact a stock’s price, but it’s almost always an indirect relationship between the buyer and seller.
The same is true for prices rising. If news breaks that Apple is releasing a revolutionary new computer, it might very well increase Apple’s profits, which is always good for its owners. So if all owners know this, they may want to hold on to their stock, or hold out for a much higher sales price. In this case, the stock price would go up (more buyers than sellers).
Should you invest in the stock market? The short answer is yes. But you need to know what you’re doing first. The first step is to find a reliable broker, then you need to start learning the basics of investing. Spend time reading through our investing articles archive and you’ll become well-versed in no time.