How Stocks Work

Entrepreneurs seeking to raise capital for their ventures have several options. They can approach family, friends, or outside investors such as venture capitalists. When the time is right, entrepreneurs may also choose to raise money through an Initial Public Offering (IPO).

Stock Ownership and Earnings

In America, 61% of families own stock shares, and the total value of all world equity holdings is $116.78 trillion.^1,2 Investors can make money from stocks in two ways:

• Dividends: When a company earns a profit, it may distribute part of its retained earnings to shareholders as dividends, which may be taxable.
• Capital Gains: By selling a stock at a higher price than it was purchased for, resulting in a capital gain, which may also be taxable.

Stock Market Indices

Tracking the stock market can be done using various indices:^3,4

• Dow Jones Industrial Average: One of the oldest and most well-known indices, created by Charles Dow in 1896. It tracks the stock prices of 12 companies by averaging their closing prices.
• S&P 500: Published by the Standard & Poor’s Company, it is based on the stock prices of 500 leading companies in the U.S. economy.
• NASDAQ Composite: Includes over 3,300 companies listed on the NASDAQ stock exchange.

Additionally, there are hundreds of other indices that track different segments of the market, such as the Wilshire 5000 Total Market Index and the FTSE4Good Index series.

History of the Stock Market

The history of the stock market is rich and spans several centuries:

• 12th Century: Banks in France had men managing and regulating the debts of agricultural communities, effectively becoming the first brokers.
• 1602: The Dutch East India Company became the first company to allow investors to purchase shares, marking the start of global stock trading.
• 1698: The London Stock Exchange traces its history to when John Castaing issued a list of stock and commodity prices at a coffee house in London.
• 1792: 24 brokers gathered under a buttonwood tree in New York City to sign an agreement establishing rules for buying and selling bonds and shares of companies, eventually forming the New York Stock Exchange.
• 1830s: Traders began trading stocks of small, newly created corporations outside the New York Stock Exchange, leading to the formation of The American Stock Exchange.
• 1896: Charles Dow calculated his first average, which eventually became the Dow Jones Industrial Average.
• 1971: The National Association of Securities Dealers (NASD) went live with an automated quotation system for trading stocks.

Largest Stock Exchanges

The world’s largest stock exchanges by market capitalization are:⁵

• New York Stock Exchange: $25.15 trillion
• NASDAQ: $18.99 trillion
• Shanghai Stock Exchange: $7.24 trillion

Modern Stock Transactions

Traditionally, shareholders received a physical Stock Certificate upon purchasing shares. However, in modern times, shares can be held electronically by the shareholder’s broker—making transactions paperless and more efficient.

Rights of Shareholders

Shareholders who purchase these stocks become partial owners of the company. This ownership grants them certain rights—such as voting for members of the company’s board of directors.

IPO Process

An IPO occurs when a company divides itself into pieces called “shares.” These shares represent ownership in the company. Once created, these shares are sold to investors as “stocks,” or more precisely, “shares of stock”.

Conclusion

The stock market plays a crucial role for both companies and individuals. It provides companies with access to public investment and gives individuals the opportunity to own part of a business and participate in its governance. Understanding how stocks work, including the IPO process and shareholder rights, is essential for anyone looking to invest in the stock market.