STOCK MARKET 101 – BASICS OF THE STOCK MARKET (Part 2 of 4)

Hi Friends

Why do companies list? In the last article (http://www.investment-in-stocks.com/stock-market-101-basics-of-the-stock-market/), we looked at what the stock market is. In this article, we will look at why companies want to list in the first place.

Suppose a local private company called MKI Pte Ltd is doing so well that it wants to expand its business beyond Singapore. However, it does not have much capital to expand. What can it do? It can borrow money. One way is to borrow money from the bank and the other is to borrow money from investors.

The banks might not want to lend huge sums of money to MKI Pte Ltd as they are not established enough and the banks might deem the company as “risky”. The alternative is to borrow money from investors like us. Investors can come from a private pool or public pool. Private investors can own part of the company without the company being listed. However, if MKI Pte Ltd wants to borrow money from public investors like us, it has to list itself in an exchange like Singapore Exchange (SGX) and become a public company. Before MKI Pte Ltd can list itself, it has to go through an Initial Public Offering (IPO) process where the shares of the company are sold to the public. To know more about the company that is going to IPO, it will release an IPO prospectus to let potential shareholders know what the company does, how it makes money, what is its competitive advantage, etc. The public is given a set period of time to subscribe to the shares. If there are more shares subscribed than that planned to be allotted to the public, the company does balloting to determine how many shares each subscriber will receive. The subscriber will then be let known if he/she received the shares subscribed for through a statement in the mailbox. A faster way to know is to check the bank account to see if any cash has been returned back to the account. If so, it means that he/she has not been allotted to the total number of shares subscribed for. The shares will then start trading in the exchange on the date stated in the IPO prospectus.

Now, back to MKI, why would investors want to buy shares in MKI? The main reason to buy shares of MKI is to profit from it. When you buy shares, you become a fractional owner of the businesses as stated in the previous article. Your stake in the company depends on the number of shares you hold as a percentage of the total number of shares the firm has issued. If you hold 100,000 shares of MKI and the total number of shares the company issued during IPO was 1,000,000 shares, you own 100,000/1,000,000 * 100% = 10% of the company.

Profiting from investing in shares can come in two forms. One is through capital appreciation, where you buy low and sell high. Capital appreciation occurs as the company grows and its cash profits increase. The company becomes more attractive to investors. This in turn gives rise to gains in stock price. The other is through passive income in the form of dividends, where cash is returned to shareholders from the profits the company makes. Do note that not all companies pay dividends.

Capital Appreciation

To illustrate what is capital appreciation and dividends, let’s say you bought 1000 shares (or 1 lot) of a local listed company called Vicom during the market crash in 2009 at $1500 and you sold it off in 2012 at $4000. You made a profit of $2500 when you only invested $1500. The total capital appreciation you got was 167% [($2500/$1500) * 100%]. In the meantime, Vicom also paid dividends to the tune of around $450 for every lot of shares owned. The total returns, inclusive of capital appreciation and dividends, is at $2950 ($2500+$450) or 197% [($2950/$1500) * 100%]. This is how investors benefit from investing in companies.

So far in this article we looked at the main reason companies list, that is to raise capital. We also briefly looked at the IPO process. In the next article, we will look at how stocks trade in the exchange.

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Research Team

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