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How the stock market works

The stock market is an organized market where shares of companies are exchanged. To truly understand it, you have to separate three moments: the company obtains capital, the shares are traded among investors and the price changes with each new expectation about the future of the business.

4 min read Practical guide

By the end

You will understand what you buy, where your money goes and how an investment can generate a return.

A stock is property, not a number on a screen

A company's equity is divided into shares. Owning one gives you a small economic stake: if the business creates value, that stake may become more valuable; if the business destroys value or fails, the investment can be lost. Ordinary shareholders rank behind employees, suppliers, creditors and taxes, so they bear more risk than lenders.

The unit price does not tell if a company is big or cheap. A company with 100 million shares at €20 is worth 2 billion on the stock market; another with 1,000 million at €5 is worth 5,000 million. The useful magnitude is the capitalization, not the isolated price.

Example

If a company earns €100 million and has 50 million shares, earnings per share are €2. If the company issues another 10 million shares without increasing earnings, that falls to €1.67: each existing share now represents a smaller claim.

Primary market and secondary market

In an IPO or follow-on offering, the company issues shares and may receive money to grow, reduce debt or finance projects: this is the primary market. Those shares are then normally traded among investors in the secondary market. When you buy an existing share, the money usually goes to the seller, not the company.

The secondary market provides liquidity and a public price. Exchanges, brokers and market makers connect orders; the broker holds the position in custody and processes settlement. The displayed price is the latest agreed trade, not an official appraisal of fair value.

How a price is formed

The order book contains buyers bidding one price and sellers asking another. A trade occurs when orders match. Their difference is the spread. It is usually small in liquid securities; in thinly traded shares it can turn a seemingly cheap purchase into an expensive entry.

Participants review expected profits, interest rates, competition and risk. A company can post record profits and fall if the market expected even more. The price reacts to the difference between reality and expectations, not just whether news is good or bad.

Check bid, ask and volume before submitting an order.
Distinguish the published result from what the market expected.
Don't confuse recent price with intrinsic value.

Where investment returns come from

The total return comes from the price change and the cash received, mainly dividends. In the long term, both depend on the cash that the business can generate and reinvest. A buyback creates value per share only if it is done at a reasonable price and does not compromise solvency.

No return is guaranteed. Inflation, taxes, fees and currency movements reduce what you actually keep. Horizon matters: a good company bought at too high a price can take years to deliver an acceptable result.

From data to a decision

What would have to create value?

This guide cannot predict the next move on its own. It can build a conditional reading: what supports upside, what increases downside risk, and which evidence must appear before acting.

Favourable reading

More cash per share, profitable reinvestment, or sustainable distributions.

Adverse reading

Dilution, excessive debt, or impossible expectations.

Required confirmation

Compare earnings and cash flow per share over several years.

Reasoned example

If total earnings rise 10% but shares rise 20%, each shareholder owns less earnings: the apparent improvement is not enough.

Applied workshop

Turn the explanation into a process

Follow these steps in order and keep the result, so you can repeat the analysis and identify what changed your decision.

  1. 1Identify whether the trade occurs in the primary or secondary market and who receives the money.
  2. 2Calculate market cap, earnings per share and the multiple; never judge by the unit price.
  3. 3Write which expectation must improve to justify a rise and which fact would invalidate it.
  4. 4Review spread, liquidity, costs, currency and taxes before turning the idea into an order.

Review questions

  • Which economic right does the share represent?
  • Is value per share growing, or only the size of the company?
  • How much return depends on the business and how much on a higher multiple?

Worked case

Complete journey of a purchase

A company issues 10 million shares at €10 and receives 100 million in the primary market. Months later you buy 20 shares from another investor for €12: the company does not receive your €240, but it has a public price and its shareholders have liquidity.

If the business increases earnings per share from €0.50 to €0.80 and the market maintains a PER of 20, the theoretical price goes from €10 to €16. If the multiple falls to 12, the same EPS would be worth €9.60. Business and valuation act at the same time.

Decision rule

Before buying, explain what you own, who receives your money, how the company generates cash and how much of the price depends on expectations.

Put it into practice

Choose a well-known company and locate capitalization, number of shares, earnings per share and spread. Explain in one sentence what you would own when you bought it and what would need to be improved to make it worth more.