What is Stock?

A share of stock represents a part of the equity capital of a publicly held company. This means that a private company decided to allow the public to be part owners of the firm and sold shares of ownership through a stock offering. If a company has one million shares of outstanding stock, then owning one share means that you own one-millionth of that company. So why would a company "sell out" to the public?

Usually because the company has plans (and needs money) for growth and expansion, and its bankers feel that borrowing the money might create too heavy a debt burden. The company looks for "investors" to finance this growth and taps the public markets for these funds.

By now you should sense that the major factor in stock prices is the earnings potential — or profitability — of a company. The value of a company, and hence a share of its stock, is equivalent to today's assessment of the value of all future earnings paid out by that company. The stock market is an auction where prospective buyers of stock, represented by brokers, meet with the sellers of stock, represented by other brokers, to agree on the price. If a company were to announce a major advancement, one that could double the earnings of the company in the future, a seller of stock would certainly expect a higher price than before the announcement. The buyer, on the other hand, would be willing to pay a higher price. Thus, we would expect to see the price of a share of stock climb immediately after a major announcement of this sort. Conversely, if a company announces bad news, we would expect the stock price to fall.

So, the fundamental cause for stock price fluctuations is the changing projection of future earnings. In addition, all things being equal, falling interest rates cause stock prices to go up, and rising interest rates cause stock prices to fall.

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