When a company wishes to raise money in order to invest in something it believes will profit the company, it can opt to do it in a number of ways; the most favoured being to sell a part of the company or to borrow money. When money is borrowed, it is usually done by bond issuance with a promise to pay up with interest.
A company can sell a part of itself in the form of stocks. This essentially means that a part of the company has been sold and the company has to split profits when they are there. Stocks are also known as equity because the people who buy the stock have equity or own a part of the company.
During the formation or incorporation of a company, a certain amount of stock is usually set up. At this stage, the stock is usually not worth anything because it is still in its infancy stage.
When it comes to the time that the company wants to raise money, they have to find people who are willing to invest in the company so that they can sell the stock to one person at a time.
When someone owns a share of the stock, it means that they own at least a certain fraction of the company. This gives them the privilege to enjoy a certain amount of profits that the company makes.
As the company grows, it may need to raise even larger amounts of money. The amount may range from a couple of thousands of dollars to several hundred million. This means that more stock will be offered to the market.
This is the part where everything becomes interesting. An initial public offer (IPO) will be made at a price that is pre-determined; for example it could be $10 per share. People who have an interest in the stock market usually peruse the wall street journal looking for IPOs.
Once a person buys the stock, they can turn around and sell it to someone else who is willing to buy it. In summary, the stocks have now turned from being just owned by a few investors to being held by several other investors. These other investors can then easily sell them openly through the stock exchange.
Once the stock has traded hands for a few times, those that are interested in buying the stock are the ones that will determine the value of the stock. For example, if the IPO was $10 then it could drop to even $1 at any time. Alternatively, the price could double or even triple.
The person who buys the stocks may be a hundred times removed from the person who had originally bought the stock but they still own a fraction of the company. Believe it or not, companies somehow keep track of their stock holders.
The value of stock may be determined by a variety of factors such as the internet. The internet, especially social media sites may either drive the price up or cause it to drop like a stone.
When it comes to stock, the only thing that it can be compared to is buying baseball cards. So long as they are being sold in the open market, they are only worth as much as someone is wiling to pay for them.
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