Before you start investing in stocks, it’s important that you understand what is the stock market and why it exists.
What is share market and how it works?
A stock market is a platform that provides public investors (people like you and me) an opportunity to buy and sell shares in companies. Companies must list their shares on a stock market via a process called an IPO (Initial Public Offering) before investors can purchase their shares.
For example, Snapchat was started in 2011, but unless you knew the founders and had tons of cash lying around, there was no way to buy shares in Snapchat. Their IPO in March 2017, however, gave everyone with a trading account an opportunity to buy and sell shares of Snapchat.
What do you call people who buy and sell stocks?
A person who buys shares of a public company is referred to as a shareholder or stockholder. Being a shareholder gives you the right to vote at shareholder meetings. You can vote on matters such as appointing a company’s board of directors and approving certain business investments.
As a shareholder, you also have the right to receive dividends (if and/or when they are distributed) or sell your shares. Voting at shareholder meetings allows you to influence the future growth of the company. While dividends and selling your shares at a high price allows you to profit from the future growth of the company.
Why do companies list themselves on the stock market?
You may be wondering what is the point of all of this. Why do companies go through all the hassle of listing their shares on a stock market? (And it is a hassle. IPOs are a long process, taking around 6-12 months. They’re expensive too—Facebook paid up US$ 182 million in fees for their IPO).
1. To raise funds
The main reason for a company to go public is to raise cash. They could be raising cash to expand their business or to pay off their debts. An IPO also helps to increase a company’s profile and consequently, may help them attract more customers.
2. To sell shares and receive cash
A less well-known reason for going public is for the founders and employees who have shares in the company to “cash out”. As an owner or an employee of a private company, your main source of income is your salary. Your company could be worth a billion dollars, but you could be cash poor. This is because while you on stock, it's paper gain and not real cash. You only have your current salary to rely on.
By listing on the stock market, employees of companies can sell their shares to the public and receive cash in exchange. Uber, for example, is currently valued at around US$50 billion. If you happened to be an early employee at Uber and got your hands on 1% of Uber, you would stand to make US$500 million (!!!) by selling your shares on the stock market!
Without an IPO, it would be extremely difficult to find buyers for these shares. There are only so few people with US$500 million lying around! And the price you obtain for these shares will be much lower.
Now that we know what the stock market is, how you make money in the stock market (dividends, buying low & selling high) and why companies choose to list their shares on the stock market, the final step is understanding why people like you and I would want to invest in stocks.
There are hundreds of different investments in this world—property, bonds, bitcoin, starting your own business to name a few—but, why stocks? Well, this is a question that deserves its own article and is something I will cover next time.