Understanding the basics of What are stocks and Stock Market: With the boom of the internet and financial platforms, one of the is biggest financial questions that millions of people are searching for is ‘What are stocks?’ and ‘What is a stock market?. Most people with zero background in commerce or business are wondering How the stock market works and even why the stock market exists.
You might have also been wondering the answers to the same questions if you are a newbie to the stock market industry. Although a simple google search can give you the bookish definition of all the above questions, however, most of them are quite boring to read and don’t explain well enough. It would be simpler and interesting if we explain the complete scenario in easier words.
In this article, we’ll cover the stock market story to explain what are stocks and the stock market. In the later section, we will also give you the the exact definition for all these for your better understanding. Keep reading
The Stock Market Story – How Companies gets listed!
It all starts with a company. Let’s say there is a company “Dailyraven Technologies”. It is a private company with two directors which means that the company is 100% owned by owners (also known as promoters). Further, let’s say that the company is in the IT industry and performing quite well.
Now the owners want to grow their company and expand in new cities. For this, the company will require money for opening new branches, hiring more employees, buying machines, and for more activities required for the expansion. And for all these, the company requires extensive capital (money).
Now, let’s see what options the company owners have to get the required capital.
At first, the company will try to get the capital from its own promoters (owners), or the owner’s family to expand the company. This is the easiest way to raise capital as the promoters can easily put their savings in the company for its growth. The other ones i.e. 3F (Friends, Family, and Fools) who might be ready to invest money in the company also comes in this first option for raising capital.
However, if the owner’s fund or 3F’s investment is not sufficient, another option for the company can be going to Angel investors or VC (Venture capitalists) for raising money.
Angel investors are big individual investors who invest in startups in exchange for some portion (stake) of the company. On the other hand, VCs are corporate/firms that fund the companies/startups on similar grounds. The owners have to give a stake of their company to these angel investors or VCs. Anyways, Angels and VCs are a little difficult to find, especially if you’re not running a very hotshot startup.
If none of the above options meet the full capital requirement for the company, then the company might also go to the bigger money source i.e. the BANKS. The 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 option for companies. A lot of debt (or loan) is always dangerous for the companies.
If all the above options don’t meet the criteria, then what’s the other option for the company ‘Dailyraven Technologies’ have now? From where can they get such a large capital? The answer is public.
Even if the company is able to get Rs 100 from 1 Crore people, they can raise Rs 100 crore.
Here, the company ‘Dailyraven Technologies’ can get a large sum of money by giving ownership of the company to the people in exchange for their money. They can sell the shares of the company to the public, whoever are willing to invest in them. And here begins the journey of the company ‘Dailyraven Technologies’ in the stock market.
A stock market is a place where the company will be able to sell its ownership (in the form of stocks) to the public.
And why will the people buy the stocks of the company ‘Dailyraven Technologies’? It totally depends on how optimistic the people are about the growth of the company in terms of earnings, revenue, products, market share etc. If the people think that the company will be able to grow to new heights by utilizing this money or if they believe in the vision of the company, then, the public will be ready to buy the stocks of Dailyraven Technologies.
Initially, the stocks will get listed in the stock exchange at a price band fixed by the company during the listing based on rigorous analysis. Nonetheless, these stock prices may rise in value as the company performs well in future, giving the investors good returns.
Thus by giving the portion of the ownership in the form of stocks, the company Dailyraven Technologies will be able to pool a great amount of money in its growth and development. On the other hand, the public gets the opportunity to invest in a growing compy and make profits in terms of growing share prices in the future.
Once the stocks start trading in the share market, the individual investors can sell their stocks to other interested investors or vice-versa through the stock exchange.
How to Invest in Share Market in India? An Ultimate Beginner’s Guide!
Now, generally, the company does not offer its entire shares to the public. Almost all of the time the owners (promoters) will keep a huge portion of the stock with them to keep the ownership in their hands. For example, Mukesh Ambani Group from Reliance Industries owns around a 51% stake in the company. The rest stake of the company has been sold to the common investors, High Net worth investors (HNI), Foreign Institutional Investors (FII), Domestic Institutional Investors like mutual funds, insurance companies, etc.
Now, let’s understand this better with another example.
Assume, another company ‘Dailyraven Technologies’ 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 other interested investors. They also decided to keep the remaining 3,00,000 shares with promoters. Here, the promoters will have 30% ownership of the company.
Quick Note: Before moving forward, we would also like to define the term free-float market capitalization. It is the product of the total shares offered to the public and the price of per share. Let’s say the company Dailyraven Technologies, 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. Further, the total market capitalization will be 50*10,00,000.
Now, let’s move the story further. The company Dailyraven Technologies 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. They also provide all the important details based on which the investors will make their investment decision. 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 enters the secondary market, where the buyer and sellers both are the public. Here, the public generally exchanges the ownership of the company among each other in order to trade/invest or simply to book profits.
That’s the simplest story of the stock and the company Dailyraven Technologies from being a private company to going public and start trading in the stock market.
Stock Market Definitions
As promised, now that you might have understood the basics of what are stocks, let us also look into the standard definitions of the above-discussed stock market terms.
A) 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.
B) 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 markets: 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.
C) 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.
D) 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 the market as a whole.
Today, we discussed what are stocks and what is a stock market. By now, you would have a basic knowledge of stocks and how the market works. The stock market provides an amazing opportunity for both companies and investors to mutually help each other and grow together. Many legendary Businessman has built great companies by going public, taking money from the common investors, and giving the investors amazing returns over time.
We hope this post was useful for you to understand the basics of what are stocks. However, this is just the beginning. Next, you need to learn little advance stock market terms like market indexes (Sensex, Nifty) NSE, BSE, Bulls, Bulls, etc. We hope you continue your stock market education journey on Trade Brains. Have a great day and Happy Investing!