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Stock Market 101: Lesson 2 – Becoming a Publicly Traded Company
Introduction: Trading stocks is basically trading ownership in companies. However, not all companies are traded on the stock market. In order to become a traded company, there are steps that must first be taken.
1) Private vs. Public Companies
When a company first forms, it is a private company and is not traded on the stock market. Eventually, a private company may decide that it wants to become a publicly traded company. In order to do this, they must issue stock certificates.
2) Going Public
When a company decides to “go public” by selling shares (stock) to investors,they have an Initial Public Offering (IPO) to sell shares. The number and price of shares issued varies with each IPO.
3) Why or why not?
Why would a company decide to go public?
Well the biggest reason is because they get all that money from selling shares. This has two benefits – it increases the financial base of the company and gives them money to expand the business.
So if companies get $$, why wouldn’t they go public?
There are many reasons but one big one is that as soon as a company becomes public they have to answer to a lot of different investors and regulators. More on this later.
Definitions-
Private company: one that does not offer stock to the general public.
Public company: one that has issued stock for purchase by the general public.
Shares (stocks): Certificates representing part ownership of a company.
Initial Public Offering (IPO): Process where a company first sells shares of stock to the public.
Wrap-up: In order for a company to be traded on the stock market, it must first issue (sell) shares in the company to investors. They do this by having an IPO. The money received from this is reinvested into the company, increasing financial stability and allowing them to expand their services/products.
Upside Bias to the Stock Market
The stock market is a remarkable environment in which to create wealth. This very fact also makes it a perfect tool for the redistribution of wealth. (Seldom has so much wealth been created on our planet so easily by so many and also taken from so many so regularly. )
The very premise of the stock market is one of capital formation. A place where business people can raise money by selling a stake in their companies also called shares. The money they raise is, at least in theory, supposed to expand and grow the businesses they are in. The money they make hopefully goes to making the business more profitable. The more profitable the business the greater the value of the shares they sold to the public should be. As a shareholder you own a piece of the company and its earnings. In the market we compete to own or sell shares of these companies.
When economies are expanding and businesses are making money hiring employees and engaging in commerce things are generally considered good. During these times people are optimistic about the present and future. Investments are made and businesses are begun to capitalize on what they believe will be products or services the marketplace is asking for. When times are good people think of owning stocks as a place to invest or speculate on the prospects for better times ahead.
In seemingly uncertain times such as recessions or depressions there are typically losses of jobs and businesses close their doors because they can’t pay their bills and keep employees on the job. It is not uncommon for stocks to lose value during these times as people begin to lose faith in the present and future. Their attitudes are reflected in their fears and they eventually sell their stocks and other investments to preserve capital and limit their losses. Fear is a great catalyst. When selling begins to accelerate people see the potential for greater losses and sell even if it is at a loss so as to preserve their money.
A nation’s money supply is the principal driving force behind the growth of stock market activity. Without money supply we would have nothing to purchase stock or other investments with. The money supply of all nations is constantly growing as new money is printed, natural resources are harvested, products are made and services rendered to be exchanged for that money in the marketplace.
Without growth in the money supply we would have to find a way to exchange for products and services and bartering is the one way for that to occur. Governments would not be able to easily tax such activities and enjoy revenue so money supply is generated to create wealth for the purpose of taxation
The growth in the money supply is easily recognized by certain factors we see everyday. Most people, over the age of 21 or so, know that gasoline and food items have increased in price over the last several years. If you have paid for a college education you know it is more expensive now than 20 years ago. Yes, you say that is just inflation. Well inflation is generally regarded as a sign that money supply growth has increased and it has filtered down to the consumer being expressed as higher prices in goods and services, generally. If there is a true scarcity of an item then prices are increased until supply and demand more closely balance each other out.
The growth in money supply has allowed more companies to go public and get financing. If money supply had not increased we would not have had the opportunity to grow new business, industry and technologies. Excessive growth in money supply does lead to inflation which is observed in every financial bubble we have created for ourselves. The recent housing and stock market booms in the 1990′s and into 2000 forward were all created with cheap and abundant money.
This growth in money supply and our demand for new goods and services has led many new companies to come into existence. Our appetite for this new and better everything has also fueled the stock market and its inexorable trend higher that began long ago.
The yearly chart of the Dow Jones average indicates how this phenomenon has played out over the last 90+ years or so. (A chart is posted on my new blog) It wasn’t until the late 1990′s that the character of the market changed some and again in 2007-08. Intense speculative bubbles caused both downdrafts in the markets during those time frames. The excess in the markets was being removed and once it was the market was free to move higher once again.
Money supply growth contributed to the market having this amazing run up in asset prices. As expressed in the chart above you can see where with few exceptions the market has been in an upward trend for the last 90+ years. This would not have been possible without growth in money supply. As with all excesses they are eventually corrected and removed from the marketplace.
To participate in the future of economic growth in the stock market one must purchase stock. Over the last 30 years or so mutual funds and retirement accounts have been marketed as places to put your money in to enjoy the benefit of a rising stock market and growing economy.
The reverse of buying stock, to participate in a stock market up move, is to sell short shares of stock. To do so you are in essence borrowing these shares from someone else who actually owns them and then to profit from the transaction you must buy the shares back and replace them. The concept is similar to buying a stock and to profit from the transaction you must eventually sell. The original person whom owns the shares you borrowed will continue to own them and collect the dividends. Not all companies will have shares available to short.
There are many factors that have conspired over the years to encourage an upside bias to the market.
1. Growth in money supply
2. Retirement accounts which purchase stock
3. Executive compensation tied to rising stock price and options
4. Growth in industry to bring new products and services to market
5. Purchasing stock to enjoy dividends (usually better than money market and savings accounts)
6. Fewer incentives to own short stock than long stock
With all the plus’ to own stock one must also be careful to select stocks whose prospects for the future look bright now and as far as you can see down the road. Not all stocks go up for ever and many that shine brightly for a time fall to earth and never regain their star status again.