How The Stock Market Works

Let's imagine that you want to start your own pizza shop. Now starting the pizza shop would require some investment.

For example, you would be investing in equipments, land, furniture, food supplies etc. All the money that you invest to start your pizza shop business is called as capital. Let's say, you would be requiring the investment of $2000 in order to start your pizza shop business.

But what will happen if you do not have the investment of $2000 in order to start your pizza shop? In that situation, you have 2 options.

You would take a loan from somebody that need to be paid with interest. Or,

Issue stock (or share the ownership in the company) to people who may be willing to invest in your pizza shop in return for a proportional share of profits that your pizza generate.

Okay, let's take both the situations one-by-one and find out the advantages and disadvantages with them.

Disadvantages

It is not very easy to take loan. In our example, if we want to take loan from anybody, then the first thing we would be doing is to convince the person that his money is safe and we will be able to return his money back. The person who is giving us loan would certainly be interested in knowing about the future plans of the business and lot more things.

Next, we will have to return all the money that we have taken as a loan with interest. This interest would increase as the time passes. The more time we take to repay the principal amount, the more interest we would be paying.

Advantages

You do not have to share the ownership of the company.

Issuing Stocks

Advantages

A company can raise more money than it can borrow.

You do not have to make periodic interest payments to your creditors.

And you do not have to make the principal payments.

Disadvantages

You have to share your ownership with the other shareholders

Your shareholders have the voice in company’s policies that affects the company operation.

So we can say that...

Companies sell stock (pieces of ownership) to raise money and provide funding for the expansion and growth of the business. The business founders give up part of their ownership in exchange for this needed cash.

The total number of shares will vary from one company to another, as each makes its own choice about how many pieces of ownership to divide the corporation into.

One corporation may have only 2,500 shares, while another may issue over a billion shares such as IBM and Ford Motor Company.

The very first sale of stocks to the public is called Initial public offering (IPO) and occurs on primary market.

Now all the shareholders can be benefited by 2 ways:

1. When a company pays out profits to the shareholder, the money received is called a "dividend". The corporation's board of directors chooses when to declare a dividend and how much to pay.

2. Or when performs well, the stock price will go up and shareholders can sell their stocks at a profit. This will happen when more investors want to buy stock in a company than wish to sell.