The Stock Exchange

Q: What is a share of stock?

A: As the term implies, when you own a share or stock you share in the ownership of a corporation. What percentage of the corporation does a share represent? That varies a lot across corporations. While each share of a given corporation is of equal value, it’s entirely up to the corporation to decide how many shares it issues. The very largest corporations can have hundreds of millions of shares outstanding, in which case a single share represents ownership of a very tiny percentage of the company.

Q: What is a public company?

A: A public company is a corporation whose shares may be purchased or sold by members of the general public on their own initiative. A corporation that picks and chooses who can own its stock is, by contrast, a private company. In this sense, a private company is rather similar to a partnership.

Q: What is the stock market?

A: It’s a shorthand term for all the buying and selling of stock that goes on. Here the term “market” is used in essentially the same sense as we speak of the “market for oil” or the “market for automobiles.”

When people talk about “the market” being up or down on a given day, they normally are looking at an index that calculates the average price movements of a group of stocks. The most popular indexes include the Dow Jones Industrial Average (it consists of 30 representative companies on the New York Stock Exchange), the S&P 500 (500 of the largest public companies) and the NASDAQ index (which includes many of the larger companies traded through dealers rather than exchanges—see the next question).

Q: How is the price of a share of stock set?

A: Some stocks trade on exchanges (like the New York Stock Exchange), which are designed to move shares directly between buyers and sellers who have indicated a desire to trade at the same price. The process is similar to an auction. Other stocks are traded through securities dealers (this is the “over the counter” or OTC market, of which the NASDAQ is a part), who buy shares from some investors and then seek to resell them at slightly higher prices to others. This is much as antiques dealers work.

In either case, the price of a stock ultimately is determined by what investors are willing to pay for it. And what they are willing to pay, in turn, depends on their assumptions about the company’s prospects for future profits (if profits seem headed up, the price should move up also, and vice versa). And their expectations of future profits depend a lot on general economic conditions. That’s why there’s a tendency for the majority of stocks to move in the same general direction in response to breaking world and national news.

Q: Is a $100 share expensive? Is a $1 share cheap?

A: You can’t judge a stock to be expensive or cheap based solely on its current price. The former company may be highly profitable, with great prospects for the future, while the latter firm might be losing money and headed for bankruptcy. The real question is whether a given share price represents good value for the money, in terms of the company’s present profits and future outlook. Since no one can really foretell the future, smart investors might have highly different views. Unfortunately, there’s no single, simple formula to determine whether or not a given stock represents a good value. This is why many people say that investing is an art as much as a science.

Q: What are mutual funds?

A: They are groups of stocks bought by professional money managers on behalf of ordinary investors. Mutual funds are a way for investors to delegate investment decision making to an expert, while also diversifying. A diversified investor has money in a number of stocks, thereby reducing the chance of being hurt badly should a single stock fall sharply. By buying a mutual fund you are buying a piece of a whole group of stocks.

Q: What’s the secret to making money in the stock market?

A: Sorry, there’s no magic formula. As already mentioned, a lot depends on predicting the future prospects for a given company or industry, and even the best professionals have spotty records in this regard. That said, those who learn how to save, who buy into quality companies and who are patient (formulating their investment goals in terms of years, even decades, rather than weeks or months) are most apt to succeed.

 source: Explaining the Stock Market to Kids by Mark Kolakowski (http://www.parentmagazineonline.com/stories/402stockmarket.asp)