The stock market is a market which brings together buyers and sellers of company shares, also known as equities.
A share is a unit of ownership that represents one of the equal proportions in which a company’s capital is divided. For instance, imagine that 5 friends want to set up a company and they have €10,000 each. Their total capital would be €50,000 and each would own 20% of the business. They could split the initial capital into 1,000 shares of €50 and each would hold 200 shares.
Equities give holders the right to share the company profits, so in our example, each friend would be entitled to receive 20% of future earnings.
The stock market provides companies with access to capital and it plays a very important role in the economy. If those 5 friends wanted to raise more capital to expand their business, they could issue new shares to investors in the stock market. Let’s say they needed €50,000 more. They could sell 1,000 new issued shares at €50, for instance, and new investors would raise €50,000 for the business and they would now own 50% of the company.
New shares are sold in the primary market through an initial public offering (IPO), where investors buy shares, providing capital to firms. Note that cash only goes to the firm when it sells shares in the primary market.
These shares subsequently trade in the secondary market. In the secondary market, investors buy and sell shares to each other and the price is set according to supply and demand.
In our example, if we buy 200 shares in the secondary market, we would own 10% of the business. If the firm prospers, so do it’s owners.
If we look back over history, stocks have been a great investment. By making acquisitions, buying back their shares and growing internally, companies have been able to increase their earnings per share. In addition, some of them have paid out large amounts of profits in dividends.