Stock Market Basics

Key Ideas

An auction has a lot in common with the stock market.  Buying stocks means buying what someone else already owns,  the price is set by a kind of bidding, prices change by the moment and depend on demand.

The price for a stock is determined using an auction system.  The price, unlike that of most consumer purchases, changes by the minute depending on the value investors place on the stock.  If the price of a pair of jeans is too high it is reduced (“goes on sale”) until it is bought.  If still not purchased, the jeans are destroyed. With stocks, the price continues to fall until someone buys.

Just as a rancher uses stock to grow a herd, or as a nursery owner uses stock to grow bushes and trees, a corporation uses stock to grow itself.

The word “stock” is also used this way by cooks who use stock to make soup.

Corporations sell stock to raise money and grow the business. When a company sells stock for the first time it is called “going public.” Most major corporations are publicly owned. Companies offer shares of ownership called stock.

As of this writing, exceptions include Mars, J. Crew, Levi Strauss, Bordens, L.L. Bean, and Hallmark.

Companies also raise money by selling bonds.   If you buy a $5,000 bond from a company it agrees to pay you back when the bond matures at some point in the future, in the meantime it pays you interest.  Bonds are more like loans. They too are traded on stock exchanges.  Bonds and stocks are often grouped together and called securities. Bonds obligate a company to pay the money back.  But when companies raise money by selling common stock they don’t pay the money back. That’s a BIG difference.

Instead of promising your money back, companies give a share of ownership. If you own stock in McDonald’s or Coca-Cola, you own a share of the company.  If there are a million shares and you own 1000, you own .001 of the company.

As owners, the holders of common stock are entitled to elect the directors of the corporation and vote on major issues.  These votes typically take place at the corporation’s annual meeting, which shareholders are invited to attend.  Most share owners vote by proxy, meaning that they authorize someone else (usually management) to vote their shares.

You could say the stock exchange sells both “new” and “used” products.  Stocks that are “new” called Initial Public Offerings, ( IPO), and “previously owned” stocks traded on the secondary market.  By far, most trading takes place on the secondary market.

When you buy shares on the secondary market, your money goes to the previous owner (minus a commission to a broker).  But when you buy an IPO, the money goes to the company issuing the stock.  Corporations raise billions of dollars yearly through IPOs.