Google is up 7% today. American Express is down by 10%. Jeff Bezos made a fortune on Amazon Inc. Warren Buffett is the CEO of Berkshire Hathaway.
Buy low, sell high?
What does all of this mean?
Stocks are all around us; in the news, on the tennis court, and at house parties. Stocks are one of the most critical segments of our economy, but the truth is most people don’t fully understand what they are and why they are so important.
So, before going forward to understand Stock Market, let us first understand the meaning of stock.
What do we mean by Stock?
In short, stocks are ownership in a company and are represented in shares. For corporations, shares are the most effective way to raise money from the general public.
So, how does it work?
Here’s the story of Jaya. Jaya is a passionate baker, known for her appetising Oreo cookies. She has a small cloud kitchen that she quickly outgrew due to crazy high demand. To grow her business on a bigger scale, Jaya needs about \$100,000 to buy in raw materials, hire more workers, and move into a larger cloud kitchen.
But there’s a problem. Jaya is young, and although the bakery is doing well, she has a personal loan and only \$10,000 to put into the company. Because she already has to pay back her loans, she doesn’t want another bank loan. She asked her friends and family to invest in her business, but none were interested.
So, to grow her bakery Jaya decides to issue shares in the stock market. Jaya puts in \$10,000 she has in her bank account, but she is still \$90,000 short. She went to the Stock market and asked the general public from the stock market to invest in the balance amount.
It means asking the general public to invest money in your business through a market where shares are bought and sold. In this market, you advertise your business, tell them about future prosperity and ask the general public to invest.
She found nine people ready to put \$90,000 in her business.
In this example, Jaya was able to raise \$ 90,000. There are now ten shareholders, Jaya, and other nine people, who each have one share of \$10,000 worth 10% each (\$10,000 of 1\$100,000 is 10%).
Each shareholder is a part-owner of Jaya’s Bakery. If the bakery increases in value, so will its shares. If the value of the bakery decreases, the stock value will drop as well. That’s how a share/stock is created!
In the Real World …
Now that you understand how a stock is created, it is easy to relate this principle to big names like Reliance and Tesla. Reliance started as a small idea, not unlike Jaya’s bakery (making Oreo cookies can never be small). And after five years of operation, Reliance issued shares to raise money. However, Reliance had issued over Nineteen million shares!
Reliance now trades on the Bombay Stock Exchange (BSE), one of the world’s biggest stock exchanges (stock market). You can openly buy a share (i.e. part ownership) of Reliance for around \$1,100 (just like those nine people who invested in Jaya’s bakery). And if you did buy a share of Reliance, you would be an owner of Reliance (be it a tiny one!).
Why Stocks Are So Important
Stocks are one of the most effective ways for a company to raise cash, and cash is one of the most effective ways to grow a company. Think of Jaya’s bakery. There is no way she could have paid for her supplies and staff, which helped her to grow, without issuing stock. A company could use that cash for many reasons that could propel growth, including hiring new employees, investing in machinery, buying inventory, etc.
Let us move forward …
What Is A Stock Market?
Think of the stock market as your grocery market. Instead of groceries, people buy shares in the stock market. Just like you switch from vendor to vendor in a grocery market in search of a good vegetable at a bargain price, investors switch from companies to companies in search of good shares at a bargain price.
There are thousands of companies whose shares are traded on the stock market. Some are there to raise money, just like Jaya’s Bakery, and some are existing companies whose shares are bought and sold by people to earn profit.
For example, Duracell does battery-making business, Havells does business of Wires and Home Switches (some of you may remember the advertisement “Wires that don’t catch fire”), Johnson & Johnson deal in baby care products, Facebook does social media networking business, Nestle Ltd. does business in the consumer sector (some of you may have had Five Star Chocolate-Nestle is the company behind this product).
Just for understanding and creating a bird-view perspective, think of these companies as vendors who offer their shares (part ownership) to the general public at a price. Now it is up to us whether we buy their shares at a price offered by them. Some buy, some switch to another company hoping to get more bargains there.
Some buy Nestle’s shares because they think Maggi is a strong brand and can give us a handsome profit, whereas some are interested in Duracell for the same reason.
Each country has its stock markets. All the listed companies participate in these markets, offering their shares to the general public.
New companies raise money (just like Jaya’s Bakery) to fund their business to grow bigger, whereas existing companies (like Reliance) allow the public to trade their already-issued shares.
What Causes Stock Prices To Change?
Stock prices change every day as a result of market forces. By this, I mean that share prices change because of supply and demand. Suppose more people want to buy a stock (demand) than sell it (supply), the price increases. Conversely, if more people wanted to sell stock rather than buy it, there would be greater supply than demand, and the price would fall.
Why does this happen? Two examples will clarify why we hear news reporters saying “the stock market crashed” or why some particular company is down by 4% or 10%, etc.
- When we heard the news that Cristiano Ronaldo, a famous football player, refused to put the coca-cola bottle in front of his conference desk, Coca-Cola’s price dropped by 4% within a day; the general public thought the profitability would go down drastically as high profile athletes are discouraging people from consuming soft drinks containing sugar. So, there was more supply than demand; people sold their shares at lower prices because of the company’s future vulnerability. Hence price went down by 4% in less time.
- Suppose, if the stock market gets to know that Jaya’s bakery raised \$90,000 last year to fund their business and it now makes ten times sales and earns twice the profit as compared to the previous year, people in the market will get tempted by the growth and demand Jaya’s bakery shares which leads the share to go up higher as there will be people who are willing to buy it at a higher price.
This is how Stock Market sentiments work. If they see a possibility to earn higher returns from the business, they buy shares at higher prices, and if they feel the company is worthless, they sell shares at a weak price.
You’ve now learned what a stock is and the working of the stock market, but how can one buy stocks from the stock market? Thankfully, you don’t have to go down into the trading pit like before—yelling and screaming your order.
STOCK MARKET IN A NUTSHELL
- Issuers use stocks to raise money for expansion.
- A company owner may be looking to sell their business entirely to the public.
- Investors use stocks to profit from a company’s performance.
- Individuals who cannot afford to own a company can now be partial owners.
- Stocks help keep companies honest as they are exposed to more public scrutiny.
- There are two main types of stock: Common Stock and Preferred Stock.
- Different classes of stock have different voting rights.