Why would the founders share the profits with thousands of people
when they could keep profits to themselves? The reason is that at some
point every company needs to "raise money". To do this, companies can
either borrow it from somebody or raise it by selling part of the
company, which is known as issuing stock.
A company can borrow by taking a loan from a bank or by issuing bonds.
Both methods come under "debt financing". On the other hand, issuing
stock is called “equity financing”. Issuing stock is
advantageous for the company because it does not require the company to
pay back the money or make interest payments along the way.
All that the shareholders get in return for their money is the hope
that the shares will someday be worth more than what they paid for
them. The first sale of a stock, which is issued by the private company
itself, is called the initial public offering (IPO).
It is important that you understand the distinction between a company
financing through debt and financing through equity. When you buy a
debt investment such as a bond, you are guaranteed the return of your
money (the principal) along with promised interest payments.
This isn't the case with an equity investment. By becoming an owner,
you assume the risk of the company not being successful - just as a
small business owner isn't guaranteed a return, neither is a
shareholder. Shareholders earn a lot if a company is successful, but
they also stand to lose their entire investment if the company isn't
successful.
It’s a tricky game!
Note that: There are no guarantees when it comes to individual
stocks. Some companies pay out dividends, but many others do not. And
there is no obligation to pay out dividends. Without dividends, an
investor can make money on a stock only through its appreciation of the
stock price in the open market.
On the downside, any stock may go bankrupt, in which case your investment is worth nothing.
Having understood this, we now want to know what makes stock prices rise and fall? If we know this, we will know which stocks to buy. In the next section we will try to understand what makes stock prices go up and down.
Next - What makes stock prices change? >>
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Table Of Contents
- What are stocks?
- Why do companies issue stocks?
- What causes stock prices to change?
- What are the Sensex and the Nifty?
- 3 important things that every investor MUST remember!!
- How to decide which stocks to buy?
- Basics of fundamental analysis!
- Earnings per share (EPS) ratio and what it means?
- Price to earnings (P/E) ratio and what it means?
- PEG ratio and what it means?
- Inflation and how it silently eats your money!
- Brokerage and taxation…