3. What is a Stock?
You must have heard the phrase “a company is going public.” This means that the ownership structure of the company is changing. If a firm was previously owned by two people – Ali and Hasan, it will now be owned by thousands of people in general public. You must be wondering why Ali and Hasan would be willing to give away the ownership of their company to random individuals? Well, because they want money!
Suppose Ali and Hasan’s firm is involved in manufacturing sports apparel and footwear in Pakistan. The company has a manufacturing facility in Karachi and ships its products to 4 major cities in Pakistan. Ali and Hasan are now interested in expanding to other cities. In order to do so, they need to invest in a new manufacturing facility. The company is currently worth Rs. 50 Million. Ali and Hasan need Rs. 9 Lakh further for expansion. They can raise this money through following ways:
- Use existing reserves of the company, if any.
- Ask from family and friends.
- Go to a bank and ask for a loan. The firm will have to return the borrowed money along with interest at some future date.
- Raise capital by selling stock to the public. Investors (also called shareholders) get a percentage of ownership of the firm in return for providing their money. The benefit of selling stock rather than taking debt for the firm is that they don’t have to return this money back to the public.
Suppose you invest Rs. 100 in Ali and Hasan’s firm called Company X. The company is willing to sell 1000 shares to the general public for Rs.10/share. In that case, you can buy 100/10 = 10 shares of this company. This implies that you own 1% of this firm. The higher the number of shares you buy, the more ownership you get in the firm.
Holders of stock in a particular firm are called shareholders. When a company offers its shares for the very first time, it’s called an Initial Public Offering or IPO. After the first time, investors or shareholders can buy and sell shares in a marketplace called the stock market.
An Initial Public Offering or an IPO is when a private company issues shares for the first time to the public. The primary motive behind an IPO is to raise money. For example, a corporation that is involved in manufacturing mobile phones may decide to launch its own distribution outlet. This corporation doesn’t have sufficient cashflows to do so and therefore, may choose to go public through an IPO.
Once the shares have been sold to the investors through an IPO, the stocks continue to be traded (bought and sold) in a stock exchange. However, this secondary market activity in a stock exchange will not affect the actual money received by the company.
You must be wondering why would the public invest in stocks if there is no guarantee of getting their capital back?
3.2. Reasons to invest in Stocks
- Over the long term, stocks tend to offer highest potential returns. Nevertheless, they are also one of the most volatile investments.
- Unlike investments in gold or property, you can start investing in stocks with very small amount of money. Therefore, small investors can also have stake in large corporations.
- Stocks are an excellent source of secondary income. They provide dividends and they change in value over time.
- Investing in stocks can help you keep pace with or beat rising inflation in the economy.
- When you invest in stock of a firm, you become its shareholder. One of the basic rights of a shareholder is the ‘right to vote.’ Therefore, you may get to participate in and vote for important business decisions of a corporation.
- In today’s world, it’s very easy to invest in stocks through online brokerage services such as that offered by FinPocket in Pakistan.