The stock market is in our face every day. On the news, published on media outlets and probably all over your social media channels when there’s been billions wiped from the market.
Have you ever stopped to wonder what shares are and what the stock market really is?
I’ll explain what both shares are and what the stock market’s for below.
Shares – An Ownership Stake in a Business
When you purchase any shares of a company in the stock market, you’re now a part owner of that company. This is why they’re called shares because you now own a share of the company.
Say you were to buy 1 share of Woolworths stock, you now have an ownership stake in Woolworths and are considered a part owner. Therefore, as a part owner you’re entitled to the profits that Woolworths make, are invited to the Annual general meetings and have voting rights.
If or when Woolworths chooses to distribute those profits it will be in the form of dividends. However, it’s important to know, no company has to distribute their profits. They can retain them to reinvest back into the business for growth.
Now, if you’re anything like me and this is your first-time reading this it’s probably a little shocking. I couldn’t believe it, and as a result it literally changed how I view the stock market. It’s not some casino or a place for the rich to get richer.
It’s a place for long term investors to trade in businesses they either want or don’t want anymore.
A Coffee Shop Example
Lets say I was going to buy a coffee shop business with a friend.
For a simple example lets say after buying the company we split the business into 4 shares, I have 2 shares and my friend has 2 shares. The only difference here from a public company is our business is private.
It’s a simplistic scenario and there are some factors that make it different. Such as, public companies have different management systems, more heavily regulated etc. All that aside, whats most important if you’re just starting to learn about shares is to remember that…
You’re buying an ownership stake in a business when you’re investing in shares on the stock market.
Inevitably, knowing this should really change the way you buy or sell shares on the stock market. It’s not a casino and you’re not playing blackjack. These are real businesses, that have real workers and behind each of those workers are livelihoods at stake.
Where does the stock market come into this?
The stock market has 2 major functions.
For the first function, we’ll continue with the coffee shop example.
Our coffee shop is making tons of money but we want to expand the company and open more shops. We don’t have enough money so we need to find investors to help fund this growth operation.
To find these investors we head to the stock market and sell our business to the public (investment bankers help facilitate this deal to the larger investors), cash is raised and our business has been split from 4 shares into 100 shares.
The investors received the 100 shares, while we received the cash. (I’ve kept the numbers and explanation small so it’s easier to follow along)
The coffee shop is now a public company and we can use the cash raised to grow the business faster.
It’s all a little confusing at first, so to sum it up. The stock market is a place for private businesses to raise capital so they can grow and expand. They do this by breaking the company into shares and selling those shares to investors. The company winds up with the cash and the investors have the shares.
The next function is what most investors know the stock market for. That’s being able to buy and sell shares to other investors.
Stock markets work like an auction house. Let me explain. I’ve decided to sell my 1 share of Woolworths stock as I need the money. To sell this share, I need to find a buyer. To find this buyer it’s easier to imagine it’s the olden days.
In the olden days to sell my 1 share I would have had to go down to the stock market and find a physical buyer who would want to buy my share. They would buy my share in exchange for cash.
In the stock market for every buyer you need a seller, and every seller needs a buyer.
Nowadays you can open your trading app and place a sell order or a buy order for your shares.
If you were buying, there would be someone selling to you. If you selling there would need to be someone buying off you.
Passive investors must be wondering, “What about ETF’s and LIC’s do I own them too?”
LIC’s and ETFs
ETF’s and LIC’s are bought on the stock market just like an individual company. However, the different structure of a LIC and ETF will give you different types of ownership.
If you buy shares in an Exchange Traded Fund (ETF) you own a share of the assets inside the portfolio.
For example imagine you bought Vanguards ETF that tracks the top 300 Australian companies, you would own a tiny share of that portfolio. Check out this link to Vanguard Australia, explaining what you own when you buy an ETF.
If you buy shares in a Listed Investment Company (LIC), you become a part owner of the company. ETF’s are a trust structure where LIC’s are a company structure.
Buying an LIC is no different to buying that Woolworths stock I’ve been harping on about.
So therefore you’d be an owner of Woolworths and an owner of the LIC. Pretty cool!
Is this information even helpful?
It’s helpful if you want to know what you’re actually getting into.
One of the main reasons new investors lose money in the stock market is they don’t even know what they’re buying when they buy a stock.
Most know it’s connected to a business but that’s really all they know.
If you’re just starting out remember this. Buying a stock is like buying a business, you’re now a part owner.
The stock market is for investors to buy and sell shares off each other, and for private companies to raise capital so they can grow and expand.
Keep it simple, that’s really all there is to it. You can dive deeper into shares depending on which type of investor you want to be.