Have you ever dreamt of owning a piece of SIA or DBS bank?

With stocks you can. Stocks (also known as ‘shares’ or ‘equities’) are basically units of ownership of a company—you get a piece of every desk, filing cabinet, contract, sale in the company, and better yet, a slice of every dollar of profit that comes through the door. The more shares you buy, the bigger your stake in the company.

Stocks are one of two traditional classes of investments and are one of the means by which companies obtain financing for their businesses. If a company sells 10 million of its shares at $1 each, then it is able to raise $10 million dollars for itself. Companies raise money for a variety of reasons, mostly to expand their businesses or to pay down debt.

How Is The Price Of A Stock Determined?

The prices of stocks are driven by the demand for them. If demand is high, stocks will be priced high. Conversely, if demand is low, the respective stocks will be priced low.

What then, gives rise to the demand for stocks? Well, a huge factor is company earnings. Take for example, a company which makes $10 in profits every year is looking to be sold for $100 in shares. Would investors buy their shares?

Potential buyers would assess their situation with the question "How much return can I get if I invested my money somewhere else?" If they buythe company at $100, they are essentially investing in a vehicle that can generate 10% returns a year. If they can't find that kind of return somewhere else, they will willingly pay the company’s $100 asking price. However, if there are higher returns available out there for the same price paid, then they may not want to buy the company shares, resulting in lesser demand and a decline in the company’s share price.

Aside from opportunity costs, the expected future earnings growth of companies also drives the demand for their shares. Back to the same example, the company may be making $10 today, but it may be expected to make $20 next year. Thus, investors may be willing to pay $150 for the company shares even though that gives them only a 6.6% return on investment this year. This is as they expect to see even greater returns of 13.3% in the following year, and possibly more the year after. This is why it is possible that companies with comparatively lower earnings than their peers can still trade at higher prices due to their higher expected future earnings growth.

What Causes Volatility In Stock Prices?

Factors that affect a stock's price can generally be separated into more 'macro' factors and more 'micro' factors. Many of these factors affect company earnings which in turn affect stock prices after the market has reacted to the factors.

Macro' factors are factors that affect the whole economy or industry. Higher interest rates, inflation, national productivity levels, politics and such can have significant impacts on a company's earnings potential and so affect its share price. On an industry level, factors include a change in industry trends, legislation restrictions, the price and availability of raw materials, the exit or entry of rival companies and the advancement of substitute industries, to name a few.

Micro' factors are factors that affect the company itself only. Management change, the company’s upcoming mergers and acquisitions, productivity of workers and such affect that individual company's earnings performance.

Fund managers and stock investors have to study both macro and micro factors to try and ascertain the profitability of a company, and determine the 'fair price' of its shares.

What causes volatility in prices is due to the different opinions and views of the future of a company's earnings growth. In a day when more people think that a company's future earnings may head downwards, there could be more selling pressure which leads to lower share prices. Naturally, the reverse happens as well (when increased optimism about a company’s prospects cause an upward movement in share price).

What Are Stock Markets?

Stock markets are places where the stocks of companies are traded.

Companies which are offering their shares for sale for the first timedo this through an Initial Public Offer or IPO in the primary market. Investors looking to invest in IPOs will ask the same 2 questions outlined above—what are the companies’ earnings potential, and whether there are other investments which might give them a better rate of return. If they decide that the companies’ earnings potential is good, and can offer a better rate of return, they will invest in them.That is why many companies that offer IPOs usually price their stocks at attractive levels.

After the IPO, the investors who have bought the stock can go back to the stock market and sell the stocks to other investors, so 'trading' of the stocks begin. A stock market is simply the clearing house for these 'trades'.

Dividends

Price increases, or capital appreciation, is not the only way you can make money on stocks. Many companies also pay yearly dividends. These are cash payments that represent a portion of profits. However, it is entirely up to the management of companies whether to pay out dividends or not as they are not obliged to. Often however, they will return a portion to reward their investors.