Sunday, October 5, 2008

Stock market is the back bone of a country's economy

Back to fundamentals ... we last talk about inflation, BLR and how bank works ...

You save money with bank.  Bank promised you 3%.  Bank lends money to businesses and gain 6% from them.  As you can imagine, bank must do a good job lending the money to 'good' businesses who can repay back the loan else bank may lose money.  'Good' businesses are those who make good use of the money to 'grow' bigger and earn more.

When a business grows big enough, it can borrow money from a better source - stock market.  Once a business is listed in a stock market, its total worth is converted to shares.  For example;
Company A worth $1 million now and it get listed in KLSE for 1 million shares, so each share is $1 each.
By the way, 'share' is just a piece of paper stating that its worth $1.  Company A did not really pay $1 out from its pocket.  On the contrary, if you like Company A and its business, you can buy that share and pay $1 for it.  Company A will have $1 extra and you will have 1 share.  It also mean you own 1 out of 1 million of Company A.  When you owns 51% of the shares, you literary own Company A.  Pretty cool huh !

So assuming all 1 millions shares are sold out instantly, that means Company A suddenly receive extra $1 million, IN ADDITION to its original worth.  If the business do well next year says its worth becomes $2 million, divided by the 1 million shares it issued.  Each share is worth $2 now.  So you have gain 100% profit from $1 to $2.
So Stock Market consists of a list of businesses 
that have been proven having substainable growth in the past, 
and relatively having large net worth.
So Bank buy stocks directly from stock market too as if it lends the money out.  Where else but stock market which already have so many 'good' businesses for them to lend their money to.  And usually get a much better than BLR return - if they continously choose the right stocks.

In a mature market, all the big businesses are listed in stock exchange ( place where you buy and sell shares ).  And all these businesses group together can represent the whole of economy.  Because whatever you eat, do and buy ... you get it from small sellers who eventually get the items from the bigger players, ie. the listed businesses.

So however small or big an economy issue is, it will be reflected in the stock market.

This is also the 1st example of "Creating Something From Nothing", a good one indeed!  Assuming 'Most' of the listed companies are 'good' companies then this Stock Exchange will continue to exist.  Everybody earns something.  Banks have more choices to lend the money to and therefore earns more.  Businesses can raise more money than before without committing to pay any interest.  General public can own the businesses they like at a very small fraction that they can afford.  Its a wonderful picture ...

As long as 'most' of the listed companies 
continue to be 'good' companies ...