What is the stock exchange?
The easiest way to describe a stock exchange (or market) is as a medium for others to buy and sell shares in companies. This can exist without an exchange but it is not moderated and not available to the common public retail investor.
Why do private companies 'sell' their business (in shares) to the Public?
To raise capital. Plain and simple, they need or want more money to operate.
You could say the stock exchange sells both “new” and “used” products. Stocks that are “new” called Initial Public Offerings, ( IPO), and “previously owned” stocks traded on the secondary market. By far, most trading takes place on the secondary market.
When you buy shares on the secondary market, your money goes to the previous owner (minus a commission to a broker). But when you buy an IPO, the money goes to the company issuing the stock. Corporations raise billions of dollars yearly through IPOs.
Some of the hottest IPO`s of the last few years are Zynga, Groupon, LinkedIn, Yelp and other hyped INTERNET stocks.
Will I own a part of these companies if I buy a stock?
Yes, although its not as almighty as you might think. You will not be invited into the board room to talk about the next business ideas. Alot of companies only sell small portions to the public, therefore when you buy those shares you own a small portion (of publicly available shares) of an even smaller portion of the entire company. Example: Company A goes public and sells 25% of its shares to the public, keeping the 75% with the management and secondary market holders. Now if you go onto your broker and make a purchase you are buying a part of the 25% which trades hands regularly.
Is there a connection between the stock of a company and the actual company?
Not at all. A company which makes a billion dollars a quarter in profit could go down, while a company selling used garbage could go up! Why? because its a FUTURE prediction and its controlled by supply and demand. Similar to selling your house, the more buyers you have the higher the price. Stocks work the same way, if there are no buyers , and there is ultimately a lot of shares available then the price will not go up much. Shares available to be bought is known as `shares outstanding`. The lower the shares outstanding, the less shares that can be bought and when alot of buyers come into a stock with LOW shares, the price will go higher alot faster. This is also a double edged sword, and can work against you.
The price of a stock is not a correct way to compare against other stocks!
You might think because company A`s stock is $100 that it must be bigger than company B which is $50. This is not the case, the reason is related to the above stated `shares outstanding`. If company A had 10 shares outstanding , the company would be worth $1000. If company B had 100 shares outstanding it would be valued at $5000, so it would therefore be a larger, but not necessarily more profitable company.