What it means
The market has two halves that people often blur together. The primary market is where a company sells new shares to investors and receives the money; the secondary market is where those shares then change hands between investors, with no cash reaching the company at all.
Prices move because buyers and sellers keep revising what they think a business is worth. Company results, interest rates, industry news and plain sentiment all feed in, which is why a share price can move sharply on a day when nothing has changed inside the business.
For a business leader the market matters even if the company is private. It sets the valuation multiples that private deals get benchmarked against, it shapes the cost of raising money, and it is where competitors' published results are judged in public.
Indices track a basket of companies to summarise how a whole market has moved. Most are weighted by market capitalisation, so the largest companies dominate the number and a handful of firms can drive the headline figure on any given day.
Returns come from two sources, price change and dividends, and only the pair together gives a fair picture. A share that barely moves in price can still deliver a solid return through dividends, while a fast-rising share paying nothing delivers all of its return on paper until the day it is sold.
In practice
Real-world examples.
Example
A family manufacturing group prepares to sell and finds that listed competitors trade at 11 times earnings. The advisers apply a discount for the lack of a ready market in private shares and open negotiations at around 8 times, so the public market sets the reference point even for a private deal.
Example
A recruitment business lists on an exchange, raising $60,000,000 of new money in the primary market. Every trade in its shares after that first day passes cash between investors, and the company itself receives nothing further from the trading.
Example
A treasurer holding surplus cash in a broad equity index fund watches the index fall 14% in a quarter. Because the money is needed for a factory payment in eight months, the board moves it into short-dated deposits, accepting a lower return in exchange for knowing the amount will be there.
Formula
Calculation
Total Return = (Ending Price - Starting Price + Dividends Received) / Starting Price
An investor buys 400 shares in a listed food group at $80.00 a share, an outlay of 400 x $80.00 = $32,000.
A year later the shares trade at $88.00, so the holding is worth 400 x $88.00 = $35,200. That is a capital gain of $35,200 - $32,000 = $3,200.
During the year the company paid dividends of $2.40 a share, which is 400 x $2.40 = $960 in cash.
The total gain is $3,200 + $960 = $4,160, so the total return is $4,160 / $32,000 = 13.0%. Of that, the capital element is $3,200 / $32,000 = 10.0% and the income element is $960 / $32,000 = 3.0%, and an investor who looked only at the price would have understated the year by three percentage points.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Halverstone Foods, an invented ready-meals producer, listed its shares at $12.00 and watched them climb to $19.00 within two years as revenue grew steadily.
In the third year the fictional company met its profit forecast almost exactly but told the market that growth would slow from 18% to about 7%. The shares fell 31% in a single session, from $19.00 to about $13.11, even though profit for the year was higher than ever. Managers inside the business found this baffling, since nothing had gone wrong.
The finance director explained it in a staff briefing: the price had never reflected last year's profit, it reflected an expectation about future profits, and that expectation had just been revised down. Halverstone changed how it guided the market, publishing a three-year range rather than a single-year target, and later share price moves on results days were considerably smaller.
Watch out
Common mistakes.
- Assuming a company receives money whenever its shares are traded, when only a new issue of shares brings cash into the business.
- Judging performance on price change alone and ignoring dividends, which understates the return on income-paying shares.
- Reading a rising index as evidence that every company in it is doing well, when a capitalisation-weighted index can be driven by a small number of very large members.
Questions
People also ask.
What is the difference between the primary and secondary market?
The primary market is where new shares are issued and the company receives the proceeds, while the secondary market is where investors trade existing shares among themselves.
Why do share prices move when nothing has changed at the company?
Because prices reflect expectations about the future, and interest rates, sector news and sentiment can change those expectations without anything happening inside the business.
Does a stock market listing suit every company?
No, because listing brings continuous reporting obligations, public scrutiny and cost, which many profitable businesses reasonably decide are not worth the access to capital.
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