Do we know what the stock market is?
I will try, in the simplest of forms, to explain the stock market. This is the way I learned the basics of what the stock market is, and it could not have been better put than it was in the first book I ever read on investing, The Neatest Little Guide to Stock Market Investing by Jason Kelly.
The stock market or equity market is a multitude of transactions between buyers and sellers (such as you and me) of stocks/shares. Stocks may be publicly listed, like Coca-Cola Company or Apple on a stock exchange, or traded privately.
But what are shares or stocks? As mentioned in the book of Jason Kelly, which I believe he explains in a terrific, clean and simple explanation:
Imagine a 10-year-old kid, Ben, who goes to school and sells magazine subscriptions door to door because he wants more money to purchase a new bicycle. Ben will unlikely become rich because the majority of the profits from selling the subscriptions will go to whomever owns the magazines of the subscriptions the student is selling.
Let’s say Ben can buy shares of the magazine subscription company. Now, he becomes a partial owner of the subscription company -a business owner. This will encourage him to sell and motivate other students to join him and sell as well. The more they sell, the more money the company makes, the more Ben’s shares will be worth, and the nicer his bicycle will be.
Now, an older Ben is able to get his hands on extra magazines and wants to teach kids how to sell subscriptions. He decides to pay them a small reasonable fee for their efforts, buys extra magazines with a portion, and puts what is left in his piggy bank. The problem is that he needs a phone to communicate with his potential employees, a place to stack all the magazines, a place to meet up, and many other things that will cost money that Ben does not necessarily have. Ben has three choices:
1) He doesn’t teach kids to sell magazines, meaning, no money.
2) He goes to the nearest bank and asks for money.
3) He sells shares of his potential business.
Number one would be bumming. Number two can be pretty far fetched for many businesses, but number three could mean business.
Now bear with me, we are getting to the part where you will “insert light-bulb here.” Ben can now go around to friends and family members offering them shares of the business in exchange for money. When he sells shares, he raises money. With this approach, Ben does not have to turn down his business idea or pay a bank for the money borrowed.
Now for simplicity’s sake, Ben decides to issue just ten shares of this new company, also known as Mister Magazine. He will keep 6 and sell the other 4 to his parents at $100 each. This potential new business is private and cannot be found in any publicly traded publication.
Well, Mister Magazine does well enough. It was able to hire multiple students to sell subscriptions and made at the end of year one, $5,000.
What does this mean to the shareholders?
Now each share is $500 ($5000 divided by 10 shares) instead of $100. Pretty cool, right?
Given that the business is such a success, it decides to go public (to trade in an exchange such as NYSE, NASDAQ, etc.) and go through the above process all over again, but now instead of offering 10 shares, it will offer millions, and with the capital collected, it will increase office space, inventory (magazines), and employees among others things.
This is, in a nutshell, what the market is –the opportunity for shareholders to own little pieces of successful companies and for the chance to prosper alongside such businesses. In other articles, I will explain in more detail other aspects of the stock market and how they influence the economy.
I would like to also thank Jason Kelly for allowing me to use some of his material from his book The Neatest Little Guide to Stock Market Investing, which is very informative as to definitions and explanations of different elements of the stock market.
You can find his books on Amazon,com:
also please remember to visit us at http://www.sonomaninvestments.com