Why Do Companies Go Public?
In this article, we will answer fundamental questions that every investor should understand before entering the stock market.
What is the Stock Market?
The stock market is a marketplace that connects companies in need of funding with investors seeking to earn a return on their savings. It functions like a commercial center where businesses (companies) sell their shares, and buyers (investors) purchase them. This process is known as the primary market.
One of the key advantages of the stock market is the ability to resell purchased shares to other investors, a process that occurs in the secondary market, adding flexibility to investments. Investing in a company that is not publicly traded can make it extremely difficult to sell your stake, as there is no established market for such transactions.
The primary market consists mainly of initial public offerings (IPOs) and capital increases, where companies sell shares to raise funds. After the IPO, shares are traded among investors on the secondary market, where most stock market transactions take place.
If the stock market is the marketplace, then brokers are the intermediaries who facilitate these transactions, earning commissions along the way.
What is a Stock Broker?
A broker acts as an intermediary between a buyer and a seller. Traditionally, brokers were individuals physically present at stock exchange buildings, executing trades on behalf of their clients. Today, thanks to the internet, all stock market transactions can be conducted digitally through a computer or mobile device.
As brokers have evolved, so too has the stock market itself. Traditional stock exchange buildings, once bustling with traders, are now largely empty, as most transactions occur online.
Key Characteristics of the Stock Market
The stock market has several defining characteristics that make it attractive for investors:
Liquidity: The ability to quickly buy and sell shares.
Profitability: Historically, indices like the S&P 500 have delivered an average annual return of over 8%.
Risk: While the stock market offers potential gains, there is always the risk of losing your entire investment.
Regulation: Stock markets are governed by regulatory bodies such as the SEC (U.S. Securities and Exchange Commission) and CNMV (Comisión Nacional del Mercado de Valores) to ensure fair trading practices and transparency.
For a company to go public, it must meet strict regulatory requirements, including publishing audited financial statements and adhering to disclosure rules to provide investors with transparency and security.
Why and How Do Companies Go Public?
A company might decide to go public for several reasons, such as raising funds for expansion without taking on additional debt. Instead of seeking bank loans (which may have high interest rates), a company may choose to allow new investors to become shareholders.
When a company goes public through an initial public offering (IPO), it determines a valuation and sets a stock price. For example, if a company is valued at $1 billion and decides to issue 50 million shares at $10 per share, it will raise $500 million from new investors while existing shareholders retain the remaining 50 million shares.
Going public means that existing shareholders see their ownership percentage diluted, but in exchange, the company receives a significant capital injection to fuel future growth.
What Are Shares?
Shares represent fractional ownership of a company. The number of shares issued affects their individual price, but the company’s overall market value remains unchanged. For example:
If a company has 100 million shares at $10 per share, its market capitalization is $1 billion.
If the same company had issued only 50 million shares, each share would be priced at $20, but the total value would still be $1 billion.
Understanding Market Capitalization
Market capitalization (market cap) is the total value of a company's shares in circulation. It is calculated by multiplying the share price by the number of outstanding shares.
To find a company’s market cap, simply search for its stock ticker symbol followed by the word "stock" in Google. For instance, searching "Facebook stock" would display its market cap at the top of the results.
Why Do Stock Prices Fluctuate?
Stock prices rise and fall due to supply and demand, market sentiment, company performance, and economic conditions. This topic will be covered in depth in our next module.
Conclusion
Understanding how the stock market works is crucial for anyone interested in investing. Whether you are a beginner or an experienced investor, knowing the basics of IPOs, market capitalization, and the role of brokers will help you make informed decisions.
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