Ever since ancient times people have invested money for a return. Clay tablets dug up in Iran and dating back to the Mesopotamian era (around 1750 BC to be specific) show evidence of people handing out interest-bearing loans.
Since then the mechanisms through which people invest for the future, in the hopes of increasing their existing wealth, have diversified greatly. One such mechanism, tracing its origins back to the 12th century, is the stock market.
During this period, French government agents traded debts from farms they were responsible for managing. In Antwerp the following century, a group of investors started trading commodities in the house of a man called Van der Beurze and soon the concept spread across Flanders.
By the mid-13th century Venetian bankers were trading government securities and being copied by moneymen across present-day Italy. It wasn’t until the 17th century, however, that a continuous trading set-up was inaugurated by the Dutch East India Company.
‘Trading generally took place in coffee houses and shares for sale were advertised in shop windows.’
East India Companies sprouted in Britain and France and their shares began being traded through brokers. Because physical stock exchanges didn’t yet exist, trading generally took place in coffee houses and shares for sale were advertised in shop windows.
Since then, markets trading business stocks have sprung up all over the world; famous ones include the FTSE 100, the Nasdaq, Dow Jones, Dax and the Nikkei 225; but hundreds of others exist, trading different shares in different jurisdictions.
The London Stock Exchange (LSE) was founded in 1773 and the New York Stock Exchange (NYSE) appeared just under 20 years later. The first US stock exchange was founded in Philadelphia in 1790, but New York quickly became the biggest.
- The world’s oldest stock market started in Belgium in 1460
- The first stock tickers were used in 1867
- The world’s most valuable listed business is Chinese bank ICBC, listed on the Shanghai Composite Index with a market value of more than $4 trillion
- The biggest initial public offering (IPO) was China’s Alibaba Group, valued at $25 billion in 2014
- Facebook listed on the NYSE in 2012, valued at $16 billion. Today its market cap exceeds $275 billion
- Glencore’s 2011 float was London’s biggest at $10 billion
Why is the stock market so popular?
Today, the stock exchange has become a major channel for businesses to raise capital. They do this to invest in growth and/or reward existing investors who might want to dilute their stake into cash or exit the business altogether.
Stock markets are highly regulated and listing on one – otherwise known as undergoing an initial public offering (IPO) – has several non-monetary benefits, including increased media attention and the prestige of being attached to an established exchange.
Because the company is selling part of its equity and not borrowing money, it does not have to back a debt or interest on a loan, meaning it can invest in growth without any negative impact on its future cashflow.
When a business lists it can ‘sell’ a slice of its total value to investors in return for a cash injection. The theory holds that as the business grows and becomes more valuable, so too does the invested stake.
If the business succeeds then investors make money; if it shrinks or goes bust then they lose money. Determining which businesses to invest in and when to buy and sell shares is a closely watched science. The best investors make millions of pounds on good bets.
A major draw for investors in equity markets is the free flow of information that fuels decision-making. Markets work because people trust them to provide high levels of accurate data about listed companies. This information is open and updated regularly, giving investors a high level of insight.
Investors use the information to assess whether shares are undervalued and therefore a good bet. They will take into consideration the senior management team, recent performance, economic conditions and each organisation’s growth plans as well as any problems or challenges associated with the business.
Public markets are also tightly regulated, ensuring fairness and transparency. Before IPO, companies undergo a strenuous programme of due diligence and are priced according to their value in the context of the market. This provides assurances that investments are above board.
People invest in public markets for the following reasons:
Potential returns are greater than interest on bank savings accounts
Ability to sell shares on secondary markets
Information flow makes investment decisions easier
Believe and trust that the system is fair
Investors include individuals as well as institutions, such as pension funds and insurance companies. People can trade on their own or through a fund manager – an expert with a track record who is entrusted with other people’s money to make it grow.
Because so many people are directly or indirectly invested in the stock market it has become intrinsically linked to the wider economy. Meanwhile, globalisation means that people and businesses in one country can rely heavily on shares traded in another.
A sudden fall in share prices is a strong indicator of economic weakness, as demonstrated by the recessions of 1990–91 and, more recently, the Great Recession of 2008–09.
‘One attraction of crowdfunding over the stock market is that it is aimed at individual investors and small institutions, making it simpler for people to back a business.’
There are plenty of alternatives to investing in publicly traded stocks. For example, crowdfunding follows the same basic principles as the stock market with a few subtle differences.
With crowdfunding, a company offers a slice of equity at a price agreed with the crowdfunding platform and investors can buy a percentage. The shareholder stands to make a profit if the invested company does well and a loss if it performs poorly. But checks and balances are put in place before the company can offer equity to make sure it is a bona fide prospect.
One attraction of crowdfunding over the stock market is that it is aimed at individual investors and small institutions, making it simpler for people to back a business.
The AIM effect
Britain’s AIM – formerly known as the Alternative Investment Market – is becoming increasingly popular with people who want to invest in smaller growing business. The market fills the gap between small businesses looking for early funding through mechanisms such as crowdfunding, and the giant businesses being traded on the FTSE 350.
AIM companies must meet strict criteria before they list and are essentially considered established, growing businesses. The level of risk to investors is therefore thought to be lower than that of backing untested startups, but higher than backing large businesses with long trading histories on the FTSE main market.
‘A word of warning: AIM is volatile and listing on the market is not a guarantee of success.’
The rewards of trading on AIM can be substantial. Take the example of Abcam, which listed in November 2005 with a placement of just over £15 million. At time of writing the company’s market cap was more than £1.3 billion. A pound invested in the company at IPO would return more than £8,600 today.
But a word of warning: AIM is volatile and listing on the market is not a guarantee of success. In fact, over the last ten years the AIM all share index (incorporating the total value of shares traded on the market) dropped from 1072.70 in January 2006 to 725.62 in January 2016.
In the same time frame the price of oil has also fallen sharply, while gold has doubled from about $17,500 per kilo to more than $35,000 per kilo today. But this latter figure represents a drop from gold’s recent peak value, reached in August 2011, of nearly $59,000. Clearly, it pays to know when to get in and when to get out.
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