Well over half the adult population of the United States owns some stock, individually or in mutual funds or retirement plans. It has become cheap and easy to purchase stocks on your iPad or mobile phone without a traditional broker. Yet we seldom consider the fascinating mechanism by which stocks are created and traded. Just where do stocks come from?
Stocks are certificates that evidence ownership in a company. Of course these certificates are no longer physical pieces of paper, but claims registered electronically in a brokerage account. Each share of stock represents a proportionate fraction of the whole company, and conveys certain rights to the holder such as the privilege of voting on important corporate actions.
Christopher HopkinsPublic stock ownership traces its origin to the early 17th century, but the Americans furnished the innovation that allowed widespread participation in equity investments: the concept of a stock exchange. What is now the New York Stock Exchange began as a weekly gathering of stockholders at a certain location on Wall Street for the purpose of trading or exchanging shares of various companies. What began as an informal flea market for shares grew into the modern NYSE, on which an average of 3.5 billion shares change hands every single business day. In addition, the NASDAQ system typically sees over 1.5 billion shares change hands daily. Numerous other exchanges around the globe insure that stock investing today is truly a global affair.
From where do all these billions of shares come in the first place? Ultimately from companies seeking to raise additional capital beyond what they can borrow. A firm wishing to offer shares of stock for sale to the public must satisfy certain regulatory requirements and make public their financial statements. Upon approval, the firm issues its first public stock in an initial public offering or "IPO." This is typically facilitated through a syndicate of investment banks directly to interested investors. Additionally, companies often go back to the well in later years to raise additional equity capital in "follow-on" offerings. Note that so far there is no role for a stock exchange, and such transactions are called "primary" offerings that raise cash for issuing firms.
The genius of the American system and a key to our dominant capital position was the advent of liquid trading markets for stocks, giving investors in IPOs the confidence of knowing they could liquidate their positions relatively easily and at a readily determined price.
Before long, a sophisticated trading infrastructure developed. By around 1870, a number of designated brokers known as "specialists" manned the trading posts at the NYSE and agreed to buy and sell shares of the companies they followed in order to assure liquidity (guaranteeing that there would always be a buyer or seller in the absence of market participants).
Today, the specialist system is largely anachronistic, as 85 percent of all trades on the NYSE are executed electronically without human intervention. Probably an equal volume trades in privately operated firm-to-firm computer exchanges called "dark pools." These deep and liquid markets for trading stocks are the secret sauce on the phenomenally powerful U.S. capital markets. Trades on the exchanges between shareholders are called "secondary" market trades, as distinct from primary transactions with the issuing firm.
The total value of publicly traded U.S. stocks stands at a whopping $26 trillion, roughly 40 percent of the entire global market. Innovations and changes are relentless. The NYSE is now owned by the Intercontinental Exchange along with 22 other exchanges and clearing firms. But individual investors presently enjoy access to stock investments that is unprecedented in terms of ease and cost.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co., in Chattanooga.