As I might have guessed, you might be wondering, why would a company sell some part of it to be owned by other people ( outsiders), and why share profit with them? Well, there are two major ways a company can use to generate capital when the need arises; the company can either borrow it from somebody else or it can raise it by selling some part of it,which is known as issuing stock. The former can either be achieved by borrowings from a monetary institution like bank or the company can issue bonds. Both are part of debt financing. When it comes to issuing stock however, the company does not have to pay pack for any borrowings, instead it shares its profits with its financiers (the shareholders). This is termed equity financing.
When you buy a debt investment such as bond, you are assured of getting your money back(the principal) along with the promised interest returns. Whereas in equity financing, this isn't the case. You assume the risk of the company not being successful . As an owner, your claim on assets is less than that of creditors. This means that if a company goes bankrupt and liquidates, you, as a shareholder, don't get any money until all the creditors ie, the banks and bondholders have been paid out; we call this absolute priority. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.
Understand this also. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends even for those firms that have traditionally given them. Without dividends, an investor can make money on a stock only through its appreciation in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing.
Having added more knowledge into the subject matter, you should feel mature enough to advance into this amazing subject. In the next few sections, i will give you the two major categories of stocks. Plus you'll get to understand briefly how stocks trade. Enjoy …
When investors talk about stocks they usually mean “common stocks”. A share of common stocks means a share of ownership of the company that issues it. The price of the company goes up and down depending on how the company performs and how investors predict the performance. The stock may or may not pay dividends which usually come from profits. If the profits fall, dividend payment may be cut or eliminated.
Many companies also issue “preferred” stock. It's similar to common stocks as it also pertains a share of ownership. The difference is that, preferred stock holders get the first dibs on dividends in good times and on assets if the company goes broke and needs to liquidate. Theoretically the price of preferred stock can rise or fall along the common. In reality however, it doesn't move nearly as much because, preferred investors are interested in dividends, which are usually fixed when stocks are issued. Preferred stock is more comparable to a bond than to common stocks.
It's difficult to find a compelling reason to buy preferred stocks. They generally pay slightly lower than the company's bonds and are no safe. The chance for their price rising along with that of common bonds has been largely illusionary.
Stocks are bought and sold on one of the many stock markets like the Nairobi Securities Exchange (NSE). The link that follows gives you a list of all African stock exchange markets list of all African stock exchange markets. Stocks sold on an exchange are said to be listed there. These are also called exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. In which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically.
The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. However we should distinguish between the primary market and the secondary market. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company's stock does not directly involve that company.
In the part 3 of the series, we will cover: what you need to know before you buy stocks, how to choose a company to acquire a share from and what causes the price of stocks to fluctuate.