STOCK EXCHANGE FUNDAMENTALS

In our previous section we learned that inventor Bob created a company to organize, produce and sell his new invention – we’ll call it a widget. He used the facilities of a stock exchange to finance the project and make this happen so that people could participate by buying units of ownership called shares. By the way, the original decision to use the stock exchange and offer shares for sale in order to raise money for the company is called an IPO or Initial Public Offering.

So, in the early days of our enterprise, that we named “Orange,” there may not be a lot of excitement in terms of the stock market. It takes time and a lot of work to build a company and begin to see the values increase. After some basics we will see how the growth of the company affects these common shares that people purchased to help the company get started. The day to day pricing of a common share or stock can be influenced by many factors, some controllable by the company, and some from outside influences.

The words “stock” and “share” are basically interchangeable for our purposes here. The company is required to report to its shareholders on a regular basis and you may be familiar with the terms of quarterly or annual reports. These are a review of the financial results of the company and usually a comment about the management’s plans for the future.

Initially, the company picked a price to sell their shares to the public – in our example this was 10.00 per share and the proceeds went to the company’s bank account. Because the company chose to use a “stock exchange” to raise the capital, the shares must be listed on that exchange so that people can see them. Anyone else, in addition to the original buyers, can buy these shares since they are now public but how and at what price? Remember earlier we said that a stock exchange is simply an auction market. In other words, a person who currently owns the shares could offer them for sale at any time and another person could be willing to buy these shares – the trick is to agree on a price.

In reality, this is not much different than you selling your dining room suite on Kijijii or Marketplace or some other way. You would list it for sale at a price you consider to be fair and a potential buyer would tell you that they are willing to pay that price or perhaps offer you a price below your listing. At some point in time you might agree to an exchange of money for the dining room suite. The stock market is a bit more organized than that and has other rules in place to protect the buyer and seller but the process is basically the same.

Let’s try and put this process into real world terms to see how it works. We will pretend that my name is Bill and I learned about inventor-Bob’s company and attempt to raise capital and was interested and impressed with the potential of his widget. As a result, I bought 100 of the initial shares that were offered at 10.00 each. George, later learned about our company “Orange” from the various PR releases / quarterly reports, etc. from the company and maybe other sources and has been watching their efforts. He thinks they have the potential to be successful and would like to own a piece of it. He is interested in buying some ownership units or shares (same thing – remember). We also need to understand that the company originally sold 500 shares and there are no more company shares available to purchase. In order for George to buy some shares, he will need to buy them from Bill or another share owner.

The stock exchange has hundreds of companies “listed” and one of them is Orange. This means that every day, and during the day, the exchange will show what people are willing to buy a share for and what people are willing to sell a share for – in this case “Orange.” Let’s introduce a couple of new terms here – bid and ask. Just like an auction sale we have one person willing to “bid” on a product at a certain price and someone else who is “asking” or offering to sell shares at a different price. This very closely relates to our efforts to sell the dining room suite on Kijijii at one price (the ask or offer) and someone else who is looking for a dining room suite and is willing to pay (buy or bid) at a slightly different price perhaps.

The whole purpose of the stock exchange is to facilitate the “exchange of shares” from the seller to the buyer at a price that is agreeable. You may have many questions about how they agree on a price and the process of this agreement. For now, the buyer and seller are not required to actually talk to each other or even know the other party. We will cover that soon since there are intermediaries and rules that govern this. However, before getting to that we will continue our conversation about common shares themselves and some of the characteristics and investment opportunities they present. The next section will go into a little more depth to help you understand more about shares. One thing that is very important to remember, the company sold the original 500 shares and received the money for it but those same shares are now owned by investors, not the company. So, any buying or selling of shares from this point on, does not result in money being added to the company’s bank account.

We are intentionally over simplifying some of this information. Our purpose is to help you understand the basics. Trading techniques and philosophies are for a different time and place. We will continue with more basic information in the next section.