When people talk about stocks, you would occasionally hear people saying the stock market is down or it is up. Well, what does that mean? What is the stock market? How do companies get listed? If you ever have these questions, well read on, because I'll try to explain what it all is.
The stock market or stock exchange (I will be using both interchangeably) is a vast place where thousands of publicly companies can be purchased and sold. There are probably about a few dozen major stock exchanges located around the world and each one of these make up the part of the global stock market. The biggest one in the world is the New York Stock Exchange, also known as the NYSE.
Not every company can be listed on the exchange. There are strict requirements companies must adhere to and financial disclosures companies must make. Once all the regulatory hurdles are completed then the stock exchanges will let these companies be publicly listed.
Another way of thinking of the stock exchange is to picture a store that sells hundreds of different brands and products. Likewise, a stock exchange is a place where hundreds of companies are listed. As an investor you can choose which company to buy into.
The Primary Secondary Markets
The stock exchange is also further divided into a primary and secondary markets. Every exchange in the world has both of these types. The primary market is where companies sells its own equity to the public, this is also called the Initial Public Offering (IPO).
While the primary market are where companies issues its initial stocks or equity to investors, the secondary market is where investors trade shares among each other. A lot of times when people invest or buy shares, it will be in the secondary market.
Overall, think of the primary and secondary market in this way: the company must go through the primary market to list its own share and attract public interest. If there is no interest in the company then the company cannot generate enough capital. After all the shares have been purchased in the primary market, these investors can in turn trade it on the stock market with other investors in the secondary market.
Benefits of the Stock Market: Companies
The stock market is an attractive way for companies to grow because it allows companies access to new capital. Some of the key benefits are as follows:
- Access to a large capital pool market which will help the company expand faster
- Good publicity to get the company's name out to the public
- Equity market (stock market) offers an alternative and cheaper way of raising money
To further explain how companies benefit from listing on the stock exchange: A company wants to build a factory to increase production, but the company doesn't want to borrow money from the bank because it is too expensive. Instead, the company decides to tap the stock market and does so by offering up ownership into the company. So the company sells part of its ownership to the public through the stock market.
Benefits of the Stock Market: Investor
From an investor's point of view, these are the benefits to purchasing stocks through the stock market:
- Allows diversification through a variety of industries and geography
- Very liquid, this means that you can cash out relatively quickly - for the right price
- Higher return than traditional savings account
- There are tax efficiencies to investing in stocks (In Canada, there are capital gain taxes and dividend taxes that helps to lower the overall tax burden)
To make things a bit more clear, when you are an investor purchasing shares in a company, you are becoming an owner in the company. As an investor you are invited to an annual shareholder's meeting where you are allowed to vote for the board of directors.
Stock Market Investing Risks
Buying shares in a company allows an investor to share in the company's success, but this also includes sharing in the company's failures and missteps. If a company misses its profit targets or negative news hit the company, generally there is a drop in price. Publicly listed companies have gone bankrupt in the past. Therefore, potential investors do beware because the entire initial investment can be lost.
Since investing in the stock market does some carry risks, it is always important to understand the company you are investing in, and understand what the potential risks are. The idea of investing is really giving money to another person or corporation, in the hopes that they can make some extra money for you. Essentially you are giving money to a random stranger so it is very important to understand what it is the company does.