What is the Stock Market?
A “stock market” is essentially a market, or “exchange”, where stocks may be bought, sold, or traded. However, there is no physical “stock market”. There is a variety of stock exchanges around the world (e.g. the New York Stock Exchange (NYSE), NASDAQ, the London Stock Exchange (LSE)), any of which could accurately be referred to as a stock market - some of which have physical locations and some which do not. Stock exchanges can be “listed” (meaning they have a physical place) or “virtual” (meaning that all trading is done virtually). In no case do investments occur “in person” by current or would-be investors actually visiting the stock exchange or market itself.
What is a “Stock”?
Stock refers to a share of ownership in a company. Companies raise capital through issuing shares in the company. There are two primary types of stock - common and preferred. Common stock is the most common form and is typically referred to as stock, share, or equity. Common stock holders are able to participate in the election of the company’s board of directors and may or may not be entitled to a yearly dividend. Preferred stock holders are unique - they typically received a guaranteed dividend although they have limited voting rights.
You can buy the stock of an individual company or you can buy stock in a fund. Funds are nothing more than large volumes of stock of various companies that are packaged together and sold in shares. They typically provide lower returns but the fact that an investor holds a peice of many equities ‘‘hedges’’ against losses in less profitable ones.
How Are Stocks Valued?
While stocks can be valued in a number of ways, essentially the value of a stock is what someone is willing to pay for it. As such, the value of a stock is determined by the market itself, such as can be seen in public stock markets or exchanges. In the case of private equity or a private company, the value of a stock is established by the company itself and is usually based on either income or capitalization. Stocks are considered ‘‘Overvalued’’ if their high price is a result of high buying volumes more than underlying profitablity, and ‘‘Undervalued’’ if they have strong potential fundamentals but investor demand for it is weak.
In the case of income-based valuation of stock, the value of the stock is established by the income of the company. The income of the company is treated as the return on investment, the investment being the full value of the company. The value of the company is divided by the number of shares the company wishes to issue and the value of the stock is the product of that calculation. Alternatively, the value of a stock may also be issued on the basis of market capitalization.
How Did Stock Markets Start?
Stock markets have been around since the 16th century. In fact, it was stocks that financed the settlement at Jamestown as well as the Pilgrim’s voyage to America. These early markets were similar to farmers markets today – they were held in open-air lots (London’s first stock exchange was under a tree) and people had to physically go there and actively buy/sell/trade their stocks. By the 18th century, some of the trading had made its way in-doors, into the back rooms of coffeehouses and the parlous of homes.
Why Do Companies Issue Stock?
Companies issue stock so that they can get money to finance their operations or ventures. While they could simply borrow the money from a bank, this would mean assuming debt, paying interest, and having to make payments, undercutting their profitability. With stock, they can get the capital they need without having to make those types of commitments.
Why Do People Buy Stocks?
Having stock means owning a share of that company; in this way when you buy stock, you can said to be a “shareholder” of the company (in the case of a fund, the fund would be the shareholder). As the company earns money, so do you; because you own a share of the company, your share goes up in value with the value of the company. People buy stock so that they can either resell it later at a higher price or collect the yearly dividends that many profitable companies pay out annually. Buying a stock with the intention to sell it shortly after for a profit is an example of speculative investing. Even a long term investment on a basket of profitable companies will usually yeild an investor higher returns than a savings account of dividends alone.
Bears vs. Bulls
Two words you may hear regarding the stock market is “bull” and “bear." A “bear” market is one where stock prices have been going down, generally meaning that stocks are undervalued and it is a good time to buy. A “bull” market is the opposite; it means that stock prices have been going up so stocks are overvalued and it is a good time to sell.
Remember, this stock market information and explanations for beginners is designed to help with the basics. Be sure to seek out more info about all the topics covered here.