Sorry guys, don’t have a joke this time.
Everybody talks about it. It’s on the news everywhere. It’s the only time when people are actually interested in the graph of a function. And it seems like there’s a direct relationship between the graph and people’s mood…
So, let’s talk about stocks.
First of all, what is the definition of stocks. It is a way of raising money by selling shares of a firm to the public. (Want a more precise definition of stock? Click here.) Just like bonds, stocks is a resort to “borrow” money from sources other than banks. For companies that issue stocks, it’s usually because they are so big and costly, that banks can’t afford to be their only financial supports. However, the value of bonds and stocks stand very differently to investors, and they are fundamentally different concepts.
Bonds are certificates of debt relationships: how much does a company owe to an investor. Stocks are a percentage of a company sold for an investor to own. The interest for bonds is its coupon payments. The interest for stocks is its dividends, which are shares of the companies annual excess profits. However, for most investors, dividends aren’t what they look for in investing in stocks, its the value of the stock itself. (We’ll talk about it in a little bit.) If the company that issued bonds goes bankrupt, the bond holders can usually claim a comparably very considerable percentage of their own money back. If the company that issued stocks goes bankrupt, the stock holders have a residual claimant which usually don’t get around to small individual stock holders. My personal understanding is that by taking a share of the company, you are also responsible for the prosperity of this company, even though essentially you don’t have a say in any matters of the company. (Unless you hold a big percentage of the company’s stocks, which I highly doubt you would, because that would be a lot of money. We will look at the scale of stocks and the companies that issue them later.)
Now that we have a basic understanding of what stock is, let’s have a look of how it is traded. When a company first sells its shares to the public, it is called an initial public offering, better known as an IPO. All percentages of the company that it is willing to sell is put on the line and people can simply shop as they want. There will be an initial offering price, the original stock price of this firm. The amount of stocks sold will be the amount of the firm “controlled” by the public until the next public offering, which don’t always happen.
The stock price we care about and we see so often everyday is not the price we buy stocks from companies, but prices of trades in stocks between investors. It is important to understand that the amount of shares in the stock market of one particularly is a set number unless the company decides to sell more or buy back. The the pricing of stocks follows the very simple supply and demand curve. The more people want to buy it, the more expensive the stock price will be, because demand increases but supply (amount of shares) remain the same, intersecting at a higher price.
What makes people decide if they want this stock or not is the value and more importantly expected future value of a company. If a company has a steady growth over the years, then the increase in value of shares of the company is very promising. With a promising future of a firm, it’s shares become more attractive to investors because it represents that the stock price could have a steady increase. Buying stocks at a lower price than you will sell it at makes you money and profits drive investors into the stock market.
Now, what’s in it for the companies? Well, stocks reaches a larger amount of people than bonds because of its promising benefits. (Sounds controversial? We’ll talk about it in my next post.) And for company founders, it is a chance to cash in the efforts they have done to the company which were stored in the company’s “market value”, but are now sold to the public. However, it also means that the original owners of the company are handing in part of their control to the outside. The company is also forced to go transparent, presenting almost every detail of itself to the world, because they have to be evaluated first before people decide to put faith and more importantly money in it, The company will also have to work hard on its public image to make sure their investors will keep their faith and money in the company.
Want to have a little understanding of the scale of stocks and the company that issues them? The above image is the statistics to Facebook’s shares of stocks. (Float is the amount of stocks sold on the stock exchanges for the public to purchase and trade.) Remember I said you probably don’t have a say in the matters of the company you hold the shares to? Well, usually you have to own at least 0.01% of a company to have a voice. Punch your calculator. You probably don’t have that much right? Not to say anything about yourself, just to give you an idea what kind of a Big Boy’s world we are looking at.
To be continued…