STOCK MARKET FOR DUMMIES
Author: Andrea Sferrazza Papa
Date of Publication: 23/05/2022
"Imagine you have started your business. You have followed your dream coming true and you have finally opened the bakery shop you have always dreamed of."
Weeks go by, and soon your shop is always full. From all over the city, people want to taste what you have for sale, and you also manage to create a takeaway service.The mood is so high that some customers would appreciate opening other stores closer to other streets and you start seriously considering it. Unfortunately, you don't have enough money.
You don't know enough about banks and how they work to ask for help. On top of that, it's your first business and you don't have any credit reliability. Finally you get an idea, and you gather your most loyal customers, who come to your place every day and really feel at home. Your proposal is to divide the business into many small parts, many 'Shares' of equal value, and divide them among several people in exchange for part of the necessary money.
For now, it can be considered as a simple exchange, a part of the business to accumulate funds from outside the company. These people really believe in your business. They appreciate the way it is running, want to see it grow and expand, so are enthusiastic about your proposal.
Here is the point: these customers will become owners of the business as a percentage of the shares held, and will be able to participate in the most important decisions. The more the value of that emerging sweet shop will grow, the more will their shares.
Subsequently, the “new owners” (from now,”shareholders”) will be able to choose to keep, or resell their shares to other people at a different price, for many reasons:
Do they still trust the company?
Do they think its value will grow?
How exchanges works today
This is a trivial example of the logic underlying the stock market of companies all over the world, which has become a global and ever-changing phenomenon, whose repercussions influence our lives in many ways. However, let's try to clarify some important features: not all shareholders enjoy the same rights or advantages. In fact, this simple explanation must be interpreted in a very complex context, such as the world of equities. Actually, there are different types of shares even within the same company, and each of them has different rights connected to the person who holds them. Mainly the difference revolves around different administrative rights and different patrimonial rights given by holding shares.
Different stocks, different rights
Let's review some examples.
COMMON STOCK: talking about stocks, we generally refer to common stock, that are the majority of stock issued by companies.
When you own common stocks, they give you the right to vote on board members and other corporate issues at a company’s annual meeting. Normally, one share equals one vote. From the economic side, some common stocks also pay dividends at the end of year, but payouts are not always guaranteed.
PREFERRED STOCK: main features are about paying dividends. If a company’s board decided to pay dividends, comparing common stock holders to others, you know the preferred stock income may very well be higher.
Sometimes this certainty about payoff is balanced by the lack of voting rights associated with the shares.
CLASS A AND CLASS B STOCKS: this type is less common, however it is useful to provide an example. Main point is creating a sort of “stock class”. Stocks of preferred class will give more rights about the company, so a few shareholders could influence the board following his own strategy and ideals. Historically, Google’s founders used this system to make the company bigger while maintaining a great influence on it.
In fact the company’s class B shares are held closely by Google’s original founders and few early investors and carry 10 votes per share. We should specify that another gain could come from selling stocks after price appreciation, if the company is performing well. Following this way, we differentiate between dividend and capital gain. This applies to all types of shares that can be traded on the market. Therefore, this difference could be easily connected to the next question: why do we invest in stock?
Investing in stocks
The stock markets today work digitally, and from your home you can access them and conclude trades during opening hours. The idea that exchanges are concluded continuously may seem strange. However, there are many motivations and incentives that can lead even a non-professional investor to buy shares.
In fact, as already mentioned, buying shares means being able to participate in the successes of the company, so as to obtain an economic return. Many people prefer to use part of their money in business rather than depositing it permanently in the bank. Moreover, it can always be considered an emotional component. Each person as a customer is free to support, even in a small part, the companies he believes in, on the basis of their requests.
Even without experience, even without the knowledge necessary to obtain large profits, money can be invested in long-term markets to escape inflation, which as we know erodes the exchange value of currencies year after year. An investment of this type follows saving logic, so that it can be defined as a "defensive investment". Finally, we should mention the amount of data that can be analyzed by talking about stocks. The main focus is on the “market price” of each share. However, it is only mentioned here that this value may differ from others, such as book value, nominal value, etc.
Analyzing stocks value
Furthermore, it is important to understand that the market essentially moves by expectations: if investors believe that the value of a share should be higher, it is likely that it will grow, and reverse. In particular, we mention two different approaches to undertake investment strategies: Fundamental Analysis and Technical Analysis. Fundamental analysis is usually taught at business administration academies. Basically, this involves the use of economic data, financial statements and balance sheet indices in an attempt to arrive at a total measure of the value of a company (it is also called "Value investing"). Consequently, the estimated value of each individual share.
On the other hand, technical analysis, as the name suggests, is based more on mathematical and statistical data, in an attempt to predict price fluctuations. The main work phase is the observation of price charts, identifying trends and patterns. Furthermore, value investing usually refers to long-term investments, while technical analysis could lead to short-term or very short-term investments. For this it is possible to understand how investors often specialize in one or the other. But generally, it is not easy to say which criteria is better. In fact, they follow different logics for a common goal. However, they can still be combined into a better, comprehensive investment strategy that takes both methods into account.