How does the stock market work? The simple guide

What is a stock and how does it work?

Definition: A stock is a certificate of ownership representing a share of a company's capital. By buying a stock, you become a co-owner of the company, which gives you a claim on its future profits and the right to vote at its shareholder meetings.

When you buy a stock, you're not just dabbling or trading an abstract symbol on a screen: you're literally buying a small piece of a real company. But why do companies issue stock in the first place? It's simple: to raise money.

Whether it's to finance new projects, expand, or conquer new markets, they need funds. Rather than taking on debt from a bank—which involves paying restrictive interest rates—they turn to investors. In exchange for your money, you get a piece of the pie.

What is the difference between common and preferred stock?

Not all stocks are created equal. When a company opens its capital, there are generally two main categories of shares:

Common stocks

These are the ones the vast majority of retail investors buy. They have two specific features:

• You get served last: If the company goes bankrupt and has to be liquidated, you are at the very back of the line.
• Unguaranteed gains, but voting rights: Your dividends are never guaranteed, and your gains depend mostly on the stock price going up. On the other hand, you have a say by voting at general meetings.

Preferred stocks

This is somewhat of a cross between a stock and a bond:

• Fixed dividends: The amount you will be paid is known in advance.
• VIP status: In case of trouble, you have priority over common shareholders. This safety net makes these stocks less risky.

Stock Market vs. Private Equity: understanding unlisted shares

What is the real difference between the public and private markets?

• Public stock markets: Being publicly traded requires the company to maintain total transparency. The flip side is that management faces enormous pressure to post good results every quarter, sometimes at the expense of its long-term vision.
• Private Equity (Unlisted): Shares are not freely traded on the stock exchange. Not being listed allows executives to calmly focus on long-term strategies and save on the exorbitant costs associated with public regulations.

Investing abroad: how to buy international stocks?

With the internet, it has never been easier to buy shares in companies halfway around the world. The benefit? Diversification. Adding foreign stocks to your portfolio is an excellent way to smooth out your risks. However, you may add a new risk to your portfolio: currency risk. We will cover this in a coming article.

• Direct investment: You buy the securities directly on the foreign stock exchange.
• Depositary receipts (ADR / GDR): These are certificates traded on your own local exchange, but which "replicate" the shares of a foreign company.

How to make money with stocks: Risk and Return

There are two ways to make money with your stocks: capital gains (when the stock price goes up) and dividends (the share of profits paid out to you).

The magic effect of reinvested dividends

The classic beginner's mistake is staying glued to the stock price. Forgetting about dividends is a monumental error! If you use the dividends you receive to buy even more shares, you trigger the compound interest machine. This system generates a large portion of the wealth created in the stock market over the long term.

How to evaluate a company and find a good deal?

Book Value vs. Market Value

Book value is the mathematical wealth of the company (assets minus liabilities). Market value (or market capitalization) is the price the market considers fair today, anticipating tomorrow's earnings. If the market believes in explosive growth, the valuation will go through the roof.

What is ROE (Return on Equity) in finance?

ROE (Return on Equity): This is the king of indicators for judging management's performance. It measures the profitability of the money provided by shareholders. The higher the ROE, the more efficient the company is at turning your capital into profit.

For example, an ROE of 32.5% means that for every dollar invested, the company generates 32.5 cents in net profit. Money isn't free: the company must generate enough return to justify the risk you take, otherwise its stock price will collapse.

In summary: The stock market isn't a casino; it's the engine of the economy. By understanding these few indicators and the magic of compound interest, you already have a head start.