How the Stock Market Works?

There are many Stock Markets in the world and they have essentially been established to allow business to get cheap financing to aid rapid expansion in exchange for a slice of the business and an opportunity to profit with the business.  The largest stock markets are located in the richest countries; this enables business to get access to the wealth and capital available in these countries to finance growth.

By purchasing stock in a company you can benefit in two ways.  Firstly you can benefit from share price appreciation, the movement of the stock price.  Secondly you can benefit if the company issues dividend payments.  Dividend payments are a cash distribution of profits as a reward to shareholders for holding the stock.  Wall Street analysis firms provide ratings of the companies and their stocks, however they can be quite misguided and they are more often than not more bullish than they should be.

Institutional Stock Analysis- Wall Street Analysts

Most of the investment banks and brokerage houses employ Stock Market Analysts. Their job is to research the firms in the industry they are allocated to, in an attempt to assess if the companies are worth investing in.  You can purchase the “Analyst Reports” from S&P, Moodys, The Street, Credit Suisse or the plethora of other information providers out there.  The analysts usually attend the shareholder meetings for the companies they cover and probe the management team for further information.  Wall Street analysts come under constant scrutiny for the meaningless jargon and inaccurate ratings they put on stocks.  There is no aligned meaning across the research houses as to the meaning of ratings such as:

  • Strong Buy, Hold, Sell, Strong Sell
  • Outperform, Perform, Under perform
  • Overweight, Underweight
  • Long, Neutral, Avoid
  • Accumulate, Hold, Distribute

The analysts tend to avoid negative opinions as they tend to receive flack from the management teams and pressure that they may lose access to the companies they cover.  Analysts are not paid for the performance of their stock ratings; therefore they have limited motivation to be really truthful.

I hope this has given you an insight into how the stock market works.

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