How does the stock market work?
It's supposed to be a source for U.S. businesses to raise capital and grow the economy. In this function it is broken, it doesn't work.
Naked shorting and other abusive practices have made the stock market one big, rigged, ponzi scheme.
Currently banking stocks are being shorted by the big bucks guys so bigger banks can gobble them up with your tax money (the bailout funds). Rep. Kucinich is investigating as this just happened to a major bank in Cleveland. Let's do this by example. Let's say you are the owner of a company that is worth $10 million. You want to share the risk (and rewards) of doing business so you decide to 'go public'. You then decide to divide your business net worth ($1m) into 1 million pieces (shares). You then decide to sell 900,000 shares to the general public on the stock exchange. Simple math places the initial offering price of your shares at $10 each. You then have an 'Initial Public Offering' (IPO) where you sell the 900,000 shares with a starting price of $10. Your business is now $9 million richer in cash but you are no longer the boss but working for the share holders. Generally cash generated by IPO's are used to expand the business, cancel debt, etc. As time progress your business makes money and/or loses money. If you make a profit your business decides how much of that profit is retained to invest in the business and the remainder is divided up among the share holds. Let's say in the first quarter after your IPO, your company made $100,000 in profit that will be given to the shareholders in the form of a dividend. Since there are 1million shares outstanding each share holder will get $.10 times the number of shares they have. You will receive $10,000 because you kept 100,000 shares. The value of a business can be determined by multiplying the number of outstanding shares (1m) times the current share market price. If the business made money and purchased assets and such, then the value of the indiviual shares will grow. If the company loses money the value of the shares fall. The buyers and sellers of the shares of your business are watching the value of your business to determine when to buy and when to sell which is all based on how they think your business will perform in the future. Buy a low priced share of a business that makes good money and the share value goes up, divindens are paid and you sell your stock at nice profit. Buy a high priced stare and the business falters and share values drop and no dividends are paid and you lose money.
There ya go. as short and simple and I can make it. Hope this answers the question. It's a little more complex than that. That's not bad, though.
A corporation can get money for something like a plant expansion in three ways: it can go to the bank and borrow it; it can borrow it by selling bonds; or it can sell part of itself by issuing stock. Bonds and loans are a subject for another day.
There are two kinds of stock: initial issue, and secondary market. In an IPO, the company whose name is on the stock certificate says "for x number of dollars you can buy y percent of this company." It normally isn't a very high percentage per share--calculate the percentage if the company puts 50 percent of itself on the market as an issue of 100,000 shares.
Most investors don't get to buy into IPOs--these are largely for institutional and accredited investors. One of the big reasons is brokerages require investors to hold IPO shares for sixty to ninety days, to prevent short-term profit taking.
The secondary market is where the real action is--brokerages buy and sell "used" stocks, and the company whose name is on the certificate never sees any of this money. When you buy a used Ford, Ford doesn't get any of this money and shouldn't; the car doesn't belong to them anymore. Same deal here.
Let's buy some Dresser stock and see how this goes. They make Wayne-brand gas pumps, among other things. They compete with Veeder-Root, who makes Gilbarco gas pumps. At the opening bell today, both stocks cost $25 per share and are stable because a gas pump company really makes its money selling parts--the pumps themselves can last for decades. Today at 11am, Dresser announced a new line of drink cases and entry doors for convenience stores that they will build in a factory they just broke ground on. Veeder-Root does not announce this. Investors realize this means a person who builds a new convenience store can either call Gilbarco, plus a refrigerated-case company, plus a door company to get all her equipment. or she can call Wayne and get everything she needs from one firm. Investors in Veeder-Root may start selling their stock so they can buy Dresser instead. As they sell, the brokerage will start to get overloaded, so it does what any merchant does and cuts the price to encourage buying. At the same time, the brokerage that has the Dresser stock knows there's not enough of it to go around, so it starts raising the price. This has two effects. First, to a limited extent stock follows
a demand curve--the higher the price, the fewer people want to buy it. This also encourages people who bought the stock already, but who don't necessarily invest long-term, to cash out and realize a profit. Eventually the stock reaches an equilibrium.
What about Veeder-Root? Gilbarco and Wayne both make good pumps, and it wouldn't take much for Gilbarco to beat Wayne--all they need do is have Gilbarco-brand doors and cases made for them--the lower-priced Veeder-Root stock will find buyers. When Veeder-Root comes in the next day and announces they've cut OEM deals with leading makers of doors and cases and that Gilbarco doors and cases will be available immediately, the tables are turned: Dresser has a piece of land on which convenience store cases will one day be made, but Veeder-Root has a complete line of equipment that people like already. Today Veeder-Root stock will get stupid expensive and Dresser will go down.
Fast forward two years. There are 600 new convenience stores with Gilbarco cases, doors and pumps. Wayne no longer has first-mover advantage, and they know it. They retaliate by introducing a case that holds twice as many sodas as Gilbarco's case does, in the same amount of floor space, and that tells the clerk when it's time to restock. Wayne receives 400 orders in the first three months it's on the market, so their stock rises and Gilbarco's falls (because Gilbarco is seen as "behind on technology").
There's also the stock split. A stock price that's too high is bad, m'kay? Fewer people can afford to buy $100 stock than to buy $50 stock, and a small percentage decline on a high priced stock looks worse than the same decline on a lower-priced one. (If you have two stocks--one priced at $100 and one at $20--a 5 percent decline on the expensive stock brings it down to $95 per share, but the same 5 percent decline on the less expensive share is only a dollar.) If a stock is outrageously expensive, the company has the option of doing a "stock split." These will be listed as "3 for 2" or "10 for 1" splits. If your company does a 5 for 1 split and the stock currently trades at $500, every $500 share will become five $100 shares--same market capitalization, but spread out over more shares.
It does seem like a bit of a Ponzi scheme. The only reason to buy a non-income stock is because you expect someone will want to buy it later for more money. Since most companies choose to reinvest profits in the business rather than pay them out as dividends, the companies gain a lot of money (through their IPO) without paying much back in return.
The basic function of the stock market is to provide capital resources for corporations that seek capital to expand their operations and finance their growth.
If you make your money available to theses companies, you help them expand and prosper.
Companies that issue stock shares to the public are considered "publicly held" or "publicly traded" companies. Stock shares represents ownership of a corporation. As a shareholder, an investor owns a portion of the company's assets and profits.
With ownership comes risk and a shareholder assume the primary risk if a business does poorly. However, they also stand to make the greatest return if it succeeds. If he is smart, the shareholder would be wise to be understanding the stock market too.
When an entrepreneur starts a company, he often looks to family and friends for start-up capital. As the company grows, it will need more money, or in other words capital. Those who survive those tough early years, when most businesses fail, will look for a bank loan.
Loans carry high cash costs, in the form of interest payments. Eventually, if the company grows enough, its owners may choose to issue stock shares in the public markets. Understanding the stock market is very important to know for these entrepreneurs.
When you hear that a company is "going public", it means that the company is issuing shares of ownership for sale in the public marketplace. This process takes place during the initial public offering. or IPO.
The IPO is a first-time offering of stock for sale to the general public. The IPO process involves a number of people in addition to the company owners, and can be a rather complex undertaking. The company itself must be clear in understanding the stock market.
To go public and issue an IPO, the company must use and find an Investment Banking firm that is willing to underwrite the public offering. The Investment Banking firm, or underwriter, will do their best to sell the shares. They may reserve the right to sell the offering on an all or none basis, which means that if they cannot find buyers for all the shares to be issued, they may call off the entire offering.
The underwriter's profit in this case is made by a commission charged for selling the stock. If the underwriter agrees to a firm commitment to sell the entire offering, usually the first move is to buy all the shares that are going to be publicly offered at an agreed-upon price.
The underwriter then attempts to sell those shares to the public for a higher price, thus profiting from the transaction.
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