What Are Stocks and Why Do Companies Issue Them?

The companies listed on the stock exchanges exceed 7,500 in India, 3,929 in the USA, and 3,766 in China. These are just some of the markets in the world, and no matter the market, companies go public for different reasons. The first thing that occurs when they go public is that investors can invest in these companies by buying their stocks.

Stocks are the fundamental units of the stock market. The question is, 'What are stocks and why do companies issue stocks?' In this stock basics guide, we will understand what stocks are and how they work in the stock market.

What are Stocks and Shares?

Stocks are a measure of ownership in a company. Suppose you buy shares of a company that is listed on a stock exchange anywhere in the world. When you buy stocks or shares, you possess a small portion of that business and become a stakeholder. You are also entitled to a portion of its assets and profits.

This ownership provides you with some rights, including the right to vote on significant decisions of the company or to share in the earnings of the company in the form of dividends. Through the stocks, the shareholders can enjoy the growth of the company with time, since the value of their shares can also grow with the business.

The words stock and share are used interchangeably across the world. Although the term shares generally denotes the individual units of ownership, the term stocks is the wider term used to denote the grouping of the units of ownership in one or more companies.

What is Equity in the Stock Market?

Equity is, in simple terms, ownership of a company. When purchasing a stock, you are actually purchasing part of the equity of that company. Equity allows the investors to share in the success of a business. In case the company is doing well, the value of your shares may rise with time. Here is how stocks work for beginners:

• Profit Sharing: In case the company makes profits, some of the profits can be given out in the form of dividends.
• Growth Participation: Although the profits may not be distributed, your equity value will grow with the growth of the company.
• Voting Rights: In certain stocks, shareholders are given a chance to vote on important decisions of the company, which gives them a say in the operations of the business.

Why Companies Go Public and Issue Shares

An Initial Public Offering (IPO) is the process through which a company goes public. The primary goal of why companies go public is to raise funds for operations and expansion, yet it's not the only reason why a company launches an IPO. Here are all the reasons why companies go public:

• Raise Capital for Growth and Expansion: The primary purpose of an IPO is to raise funds to grow, expand or pay off debt. Issuing shares brings funds from the market, helping the company meet financial needs.
• Exit Route of Existing Investors: Listing allows promoters or private investors to sell some or all of their shares by an Offer for Sale (OFS), which offers an easy way out.
• Liquidity and Marketability: After listing, shares can be easily traded in the stock exchange, making them liquid and appealing to investors.
• Improve Stakeholders' Trust: Adhering to stock market regulations leads to transparency, minimises fraud risk, and increases investor and other stakeholder confidence.
• Possibility of Takeovers: Listing can be used to raise funds that can be used to acquire smaller companies to enhance growth and profitability.
• Employee Motivation through Employee Stock Ownership Plan (ESOPs): Through ESOPs, listed companies are able to sell shares to employees, enhancing retention and minimising cash compensation expenses.
• Enhanced Visibility: Listing enhances brand recognition and publicity, attracting investors and analysts, improving market reputation and share demand.

What is Stock Market and How it Works?

When a company goes public, its shares (stocks) are listed on a stock exchange. A stock exchange is a regulated platform where buyers and sellers meet to trade shares or stocks of companies. Individual investors, institutional investors, and traders place buy or sell orders through brokers or online trading platforms that are connected to the exchange. Here is how the stock market works:

1. Company Lists Shares: A company that is going public lists its shares on a stock exchange. This makes them available for buying and selling by the investors.
2. Investors Place Orders: Buyers and sellers use brokers or online platforms to place buy or sell orders. The orders are executed when a matching price is located.
3. Supply and Demand Determine the Price: When there are more people who want to purchase a stock as compared to those who wish to sell it, then the price increases. When the number of people who wish to sell is more than, the price decreases.
4. Trading Occurs on a Continuous Basis: Trading of shares takes place during market hours. Prices are always changing depending on the mood of the market, the performance of the company and other external influences.
5. Investors Make or Incur Losses: The returns are either capital gains (selling at a higher price) or dividends. The losses are incurred when the price of the stock is lower than the price of purchase price.
6. Stock Market Liquidity and Transparency: Shareholders can readily liquidate shares. Trades are fair and controlled for all players.

Advantages of Issuing Shares to Companies

Here are the key benefits of issuing shares that investors and traders must know:

• Access to Long-Term Capital: One of the key benefits of issuing shares is that it gives companies access to long-term capital that they can use to expand, conduct research, undertake new projects or upgrade technology. It does not require repayment as loans do.
• Better Visibility and Credibility: As a publicly listed company, it enhances confidence among investors, partners, and customers. It improves the image of the company and draws in new business.
• Ability to Compensate Employees through Equity: Employees can be given stock options or shares by the company as a form of compensation. This makes the employees have interests that are aligned with the growth of the company, and it also helps in retaining talent.

Understanding How Stock Ownership Creates Value

By owning a stock, you are not merely holding a part of a company; you are a part of its growth and prosperity. Here is how owning stocks creates value:

• Capital Appreciation: Your shares may go up in value as the company expands and becomes more profitable. When you sell your shares (stocks) at a price higher than the price you paid, you make a capital gain.
• Dividends: Many companies distribute part of their profits to the shareholders in the form of dividends. A dividend is a stable stream of income as long as you hold on to your shares.
• Long-Term Growth Mindset: The stocks should be treated in a long-term view. Companies expand, become innovative, and grow over time, and this may add value to your ownership.

Conclusion

Stocks offer one of the most lucrative ways to outpace inflation, build wealth, and create value. When you are investing in stocks, however, risk will come only from not knowing what you are doing. Understanding what stocks are and how the stock market works allows you to get a better idea of the market fundamentals.

Owning shares, whether in terms of capital appreciation or dividends, will enable you to share in the success of a company, and companies will get the capital they require to grow and innovate. Understanding stocks and shares gives a solid ground to navigate the stock market with confidence and a long-term outlook.