Stonks

This is the first installment in a series on finance and the stock market. I am well aware that this has been done a thousand times by people who are both better writers and better educated on the subject, but it hasn't been done by someone with over 200 IQ yet (technically true). On to things...

What is a Share?

A share, broadly speaking, is a portion of a business which can be bought and sold freely. A company can have as many shares as it wants, and those shares don't have to be publicly available. One important thing about shares is that you can't own a fraction of a share, you either own a full share or don't own it at all.

What is the stock market?

The stock market is basically Kickstarter+. It exists primarily as a one time injection of funds for a business through the selling of its own shares, as well as a good bit of publicity.

How do companies get on the stock market?

The process of getting shares of a company on the stock market (called an initial public offering or IPO) is (in list format 💦):

1. A company decides to go on the stock market (known as going public).

2. They find an underwriter, and make an agreement to sell at a certain price.

3. The underwriter sells on those shares to investors.

4. The shares begin to trade on a public exchange

Let's go through each of the steps with a simple example.

0. Starting the company

I start 'Al's Game Company' (AGC), and at the beginning I own 100% of the company (which is worth nothing). The company then makes a lot of money selling my awesome board games (because why not), some of which is reinvested in the company. At this stage, 'Al's Game Company' is a private company, because it is not available for the public to buy, and we will say it is worth $1,000,000,000.

1. Deciding to go public

I decide that the company has potential and needs investment to live up to its true potential, so I decide to go public*. Other reasons to go public are:

• To generate free advertising

• To allow investors to cash out

'Al's Game Company' is divided into shares. In this case, let's say AGC is divided into 10 million shares, each 'worth' $100 ($1bil/10mil). At this stage, I (Alastair) own all 10 million shares.

At the stage before the company goes public, the finances look like this:

The pie graph on the left is the company's assets in dollars by type, and on the right is the number of shares by ownership. Note that if the company can't buy anything, as it doesn't have any cash, and therefore will have trouble expanding without some kind of loan or an IPO.

To sell shares and enter the stock market, the company must first create new shares, as it can't just 'steal' shares from the current owners. 'Al's Game Company' therefore decides to create 4 million shares, which sit in an unowned state (they are owned by the company) until they can be sold.

2. Finding an underwriter

Before AGC can sell any of its newly-created shares, it needs to find an underwriter who will act as a middleman and guide the company through the process. I decide to go for 'Liam's Investment Giant Management Association' (which I won't abbreviate for obvious reasons). They (through a long and complicated process), tell me that I should sell my 4 million shares at $100 a pop.

You can look at the blue sections above as what was already there, and the other section has been added to the pie by this process. Note especially that I (the initial shareholder) have not lost anything (i.e. my share in the company is still worth $1bil)***. Also, note that the $400,000,000 is in cash which allows it to be deployed immediately to expand the company. This cash is also not balanced by an opposing liability such as debt, which makes selling shares such a popular option for large companies whose investors want to cash out.

From now on, the company itself doesn't get any money from those stocks.

3. The Underwriter sells these shares to everyone else

It's an oversimplification, but broadly, 'Liam's Investment Giant Management Association' sells these shares (at a profit) to other companies and individuals. This occurs before the stock is listed on a public exchange like the ASX.

Note that even though the underwriter sold each share for more than $100 (let's say $110), the company does not get any of that money. Moreover, note that it doesn't matter to me the initial owner or the company at all who owns those 4 million shares, our involvement ends when the underwriter signs the agreement to buy them.

4. The shares are listed on an exchange

Finally, the shares are made available for everyone to buy on a stock exchange. Everyone who owns those shares can buy and sell them freely. That's the interesting part for retail investors (read: normies) like us.

Afterward

I looked a whole bunch of sources for this, and would like to note this one in particular for its great explanation and brevity: IPOs explained (4:00).

PLEASE NOTE: The purpose of this blog is less to explain these concepts (because writing the damn thing is how I myself learned), and more to whet your interest, so much of it may be inaccurate and it certainly is incomplete. Please comment with any corrections or comments, and make sure to sub!

*Please note that most companies that are worth 1,000,000,000 have more complicated ownership and investment structures than 'Al's Game Company'.

**Also note that 'ownership' =/= control. There are such things as non-voting shares and other ways they differ.

***But I would have lost nominal value if Liam's company had decided to value the company at $90 a share (the assumption is that Liam's company is better at valuation than whatever method we employed though).