How to invest in stocks? Many people don’t even ask questions out of fear or prejudice. Yet stocks can be a profitable alternative to more traditional forms of investing. They can (and should) be a pillar of your long-term savings. However, before you invest in stocks, you need to know a few basics. What is a stock? How does it work? We explain it in this guide, so you can understand and invest intelligently.
What is a stock?
Every company has an owner. Some have only one, and others have thousands. The latter have deliberately chosen to divide their business into lots of little pieces of property: stocks. These shares can be purchased and made by the purchasers’ co-owners of the business (shareholders). If a company has 10 stocks and you own one, then you own one-tenth of the shares in that company.
Companies that issue stock often take the legal form of a corporation. These companies can proceed to an IPO to make their stock more accessible and raise more funds (Initial Public Offering). This introduction will allow them to distribute their stocks more widely, which will then be traded on the stock exchange.
What is the stock exchange?
The stock exchange is a marketplace where securities are exchanged, particular company shares (stocks). It is also where the prices of the different stocks (prices) are determined, resulting from the meeting between supply and demand. Anyone can buy stocks and invest in the stock market if they have a security account that allows them to access the market.
Like any market, the stock exchange is where goods (stocks in this case) are exchanged and where buyers and sellers meet. However, the stock exchange has 3 significant advantages compared to a traditional market: it is standardized, regulated, and remarkably efficient.
- When you buy a stock, you can be 100% sure that you will receive for your money the same thing as anyone else buying a stock at the same time as you. The products are interchangeable and identical in quality. This is an essential condition for the proper functioning of the stock market.
- Regulation: Stock market transactions are subject to strict controls and regulations. To be listed on the stock exchange, companies must meet strict requirements: they must be monitored by supervisory authorities. They must regularly publish their figures and balance sheets.
- Efficiency: The image of the stock exchange with overexcited and stressed men juggling three phones and shouting buy orders across a hectic trading room no longer corresponds to reality. Today, an electronic platform brings together buyers and sellers around a price in a fraction of a second. It executes the transaction in an automated way. The stock exchange is now the most efficient market in the world.
Why does a company issue stocks?
Let’s take a simple example. Marie owns a successful cupcake store in Paris. Marie wants to open a second one but needs capital to cover this new investment. She has two options: ask the bank for a loan (external debt financing) or bring in new investors (equity financing).
Since Marie’s company is very new, the chances of obtaining an attractive loan from the bank are low. She, therefore, decides to resort to what is called an IPO (Initial Public Offering). Marie sells stocks in her company to investors, which allows her to raise enough capital to open new stands. By generating more profits, Marie can then decide to reinvest all or part of these profits in her company or distribute them as dividends to her shareholders.
The purpose of this financing can be diverse. It will depend in part on the level of maturity of the company. A young startup, for example, will sell shares of its capital to develop its product and invest in its first market. For example, a more mature company may want to expand into new markets, which is called “development capital.” We speak, then, of seed capital.
These types of fundraising correspond to different risk profiles and, therefore, different types of investors. Generally, investing in a young company in its seed phase is riskier. It is referred to as “venture capital.” Companies that are listed on the stock exchange are more mature. We, therefore, advise new investors to focus on them.