Why Stock Market Exist?

Almost all big corporation started out with a small operation and growth become a giants company. Wal-Mart was originally a single-store business in Arkansas. Dell computer started with Michael Dell selling self assembly PC from his house garage. How did these small company end up become the financial giants in US economy?

When a company is growing, company owners generally raised capital by selling stock to investors in exchange for giving up a tiny stakeholder of the company, or dividends to shareholders, they are given cash to fund growth and expand the business instead of borrow money. Beside that, a company also can using their own stock for acquisition another businesses instead of paying cash.

If you have a company making profit over $300,000 per year and you want to expand your business by open another two new branches which will cost you about $2 million, you decide to sell stock instead of borrow money from financial institution.

You underwriter recommended selling stock for 20 times earning of your company base on the similar company in the same sector. So, you company earns $300,000 profit a year with $2 million book value, your company is worth $300,000 x 20 = $6 million plus your company book value of $2 million, which is $8 million dollars company.

Now you own 1005 of your company and if you sell more stocks of your company, you will raise more cash but also giving up a larger part of your company ownership. When the company grows, the stakeholder will be worth more. Let say you decided to sell 40% of the company stocks  to publics as common stock and keep another 60% to yourself. In other words, you will keep $4.8 million worth of the business to yourself which is majority of the stock to allow you to continue control of the company and you will raise $3.2 million from the 40% common stock to sell to public.

Now you own less of your company but the grow of your company will be expected faster due to two more new branches. The two new braches make $500,000 a year in profit but the old store still making the same $300,000. Your business now making $1.3 million dollars a year, with 20 time earning, now it worth $1.3 million x 20 = $26 million plus $6 million book value of three stores which is $32 million company now. You get wealthier follow by your company public listed because your 60% ownership is worth $19.2 million dollars now. Later on, if you decided to retire and enjoy your life with your family, you just want to sell stocks in company at any time to raise cash quickly instead of looking for someone who is willing to buy over your whole company if it is now public listed.

In Stock Market like Wall Street because of human nature – the emotions of fear and greed – a company can sell for far more or less than its intrinsic value. The good investor’s job is to identify those companies that are selling below their true worth, and buy as much as they can.