What are stocks? And what is a Stock Market?
What are stocks and what is a stock Market? This is probably the biggest financial question whose answer billions of people are searching for. “What are stocks?”,”What is a stock market?”,”How stock market works?”,”Why stock market exists?” You might have also wondered the answers to these questions if you are a newbie to stock market industry. Although a simple booking answer/definition of all the above questions can be found easily in a book or online, it would be simpler and more interesting if we explain the whole scenario in the form of a story.
In this article, we’ll cover the stock market story to understand what are stocks. In the later section, we will also give you the standard definition for all these for your better understanding. Let’s get started.
The Stock Market Story
It all starts with a company. Let’s say there is a company XYZ. It is private company which means that the company is totally owned by the owners (promoters). Further, let’s say that the Company XYZ is a manufacturing company and is doing well in its industry.
Now the owners wants to expand their company in new cities and also to perform new Research and development in their field for growth. And for all these, the company requires capital (money).
Now, let’s see what the options for the owners to get the required capital.
At first, the company will try to get the capital from its own promoters (owners) to expand the company. This is the easiest way to raise capital as the promoters can easily put their their savings/holdings in the company for its growth. A similar option can be going to FFF (Friends, Family, Fools) who might me ready to in invest money in the company. If both these are not sufficient, another option can be going to Angel investors or VC (Venture capitalists) for raising money. But here, the owners have to give a portion of their company (Stakes) to these investors or VCs. Moreover, Angels and VCs are a little difficult to find.
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If none of the above options meet the full capital requirement for the company, then it has to go to the biggest money source, the BANKS. These banks can give big loans to the company for which they have to pay some interest and have to fully return the capital at the end of the term. However, paying debts along with interests can be a troublesome options for companies.
Them, what’s the option for the company XYZ now? From where can the company X get such a large capital? The answer is public. The company XYZ can get a large sum of money by giving a little ownership of the company to the people in exchange of their money. And here begins the journey of the company XYZ in the stock market.
A stock market is a place where the company will be able to sell its ownership (in the form of the stocks) to the public. And why will the people buy the stocks of the company XYZ? It totally depends on how positive the people is about the growth of the company in terms of sales, earnings, revenue etc. If the people think that the company will be able to grow to new heights or if they believe in the visions of the company X, then, the public will buy the stocks to trade their money with the ownership of the company. These stocks may rise in value as the company performs well in future, giving the public investors good returns.
Thus by giving the portion of the ownership, the company XYZ will be able to pool a great amount of money for its growth and development.
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Now, generally, the company does not offer its complete shares to the public. Almost all of the times the owners (promoters) keep a portion of the stock with them to keep the ownership in their hands. For example, Mukesh Ambani from Reliance Industries own around 51% stake of the company. Rest they have sold to the public, FII, DII etc.
Let’s understand it better with another example. Assume, the company XYZ decided to provide 10,00,000 shares which constitutes the entire value of the company. Out of the total, it decides to offer 7,00,000 shares to the public and to keep remaining 3,00,000 shares with promoters. Here, the promoters 30% ownership in the company.
Quick Note: We would also like to define the term free-float market capitalization here. It is the product of the total shares offered to the public and the price of per share. Let’s say the company XYZ’s each share price costs Rs 50 and it offers 7,00,000 public shares. Then, the free float market capitalization here will be equal to 50*7,00,000. The total market capitalization will be 50*10,00,000.
Now, let’s move the story further. The company XYZ has decided to enter the stock market. When the first time the company enters the market, it has to provide an offering price of the shares for the public to buy. This process of entering the market is called initial public offering i.e. IPO (or going public). The IPO is offered in the primary market, where the seller is the company and the buyer is the public. After the IPO, the stock goes to the secondary market, where the buyer and sellers both are the public. Here, the public generally exchanges the ownership of the company in order to trade/invest or simply to book profits.
That’s the simplest story of the stock and the company XYZ from private stage to going public.
Stock Market Definitions
As promised, now that you have understood what are stocks, let us also look into the standard definitions of the above discussed stock market terms.
— Stock: A stock is a general term used to describe the ownership of any company. Stock represents a claim on the company’s assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Shares, equity, or stock, all basically mean the same thing.
— Stock Market: The stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. It is a place where shares of publicly listed companies are traded. The stock market can be split into two main sections: the primary market and the secondary market.
- Primary Market: It’s where new issues are first sold through initial public offerings. Retail Investors, mutual funds, domestical, and foreign institutional investors buy the share from the promoters. Institutional investors typically purchase most of these shares during this first-time issue by the company.
- Secondary Market: All subsequent trading goes on in the secondary market where participants include both institutional and individual investors.
— Initial Public Offering (IPO): An IPO is the first time that the stock of a private company is offered to the public. It is a source of collecting money from the public for the first time in the market to fund its projects. In return, the company gives the share to the investors in the company. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately-owned companies looking to become publicly traded.
— Market Capitalization: Market Cap or Market capitalization refers to the total market value of a company’s outstanding shares. It is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to its competitor, industry and market as a whole.
In this post, we discussed what are stocks and what is a stock market. By now, you would have a basic knowledge of stocks. However, this is just the beginning. Next, you need to learn little advance stock market terms like Sensex, NSE, BSE, Bulls, Bulls, etc.
I hope you continue your stock market education journey on Trade Brains. Have a great day and Happy Investing!
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Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting