Purpose of the Stock Market
The stock market allocates capital to publicly traded companies based on the subjective opinions of millions of investors. Over time, capital tends to accumulate in businesses that have effectively grown their profits year over year, and their stock prices go up. Stock prices can gyrate up and down altogether or all alone, moving on hard facts, rumors or half-guesses.
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Significance
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Companies decide to open themselves up to public investment over the stock market because it is one of the easiest and least-risky ways for a company to raise capital. On the other hand, it subjects them to numerous onerous reporting requirements--they have to share substantial amounts of data about their operations to the public and their investors in particular. This makes it so that such companies are more vulnerable to competition, as their competitors will have a better idea of their operations than if they were a private company.
Function
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After a company issues public stock, it typically goes years without issuing anymore; this is a process called "stock splitting," which some companies do more than others. Once the stock has all been issued, it belongs to whomever owns it. When a stock is traded on the open market, the money goes from a buyer to a seller, and then the stock is transferred. The company from whom the shares are derived does not earn a profit from this exchange.
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Features
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Through this process of buying and selling, the price of a particular company's shares is determined according to the level of supply and demand. If more people demand a stock, it will be in shorter supply on the market and its price will increase. This in turn increases the company's market capitalization. As most companies own substantial portions of their own shares, they can then sell them at a profit or use their increased on-paper value as collateral for issuing bonds or taking on other forms of debt.
Considerations
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The stock market, over the long term, allocates resources away from companies that do not perform well and sends them toward ones that do. In the short term, the prices of stocks can be determined by almost anything and are not necessarily indicative of how well a company is actually performing.
Benefits
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Many companies and individuals make large portions of their profits and income from trading stocks on the open market. Some of these companies like mutual funds and hedge funds trade stocks on behalf of their clients. Some companies invest part of their profits into other companies to attempt to realize greater returns on their funds. Educational institutions invest with their endowments to attempt to bring greater funds to provide for new facilities and other such things that help them improve their service.
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Resources
- Photo Credit luisvilla, Flickr
