How does a company get profited by people investing in shares?

There are 2 types of capital market.

  • Primary
  • Secondary

Primary market is the part of the capital market that deals with creation of new securities (equity, debenture etc). Companies, governments or public sector institutions can obtain funds through the sale of a new stock or bond issues through primary market. Eg :- IPO (Initial Public Offering).

A secondary market is a market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges – such as the BSE and NSE are secondary markets.

Lets simply it.

Suppose you incorporated a company named xzy ltd.

You become enthusiastic for your vision so decided to pull funds from all over the India. You applied in SEBI for Public issuing. Bingo! you received positive response.

You fetched 1000 crores by issuing 10 crore shares. Face value 100 INR per share. All the application was fully subscribed. No default.

All the process until now comes under Primary Market.

Company is working well with 1k crores and allocated them in different operational assets. But now some investors gone pessimist on company’s future and decided to sell their stocks to other optimist investor.

As your company is already listed on stock exchange, so the investors sold their shares to others through their respective brokers. This is done in secondary market.

Here’s the crux…

How does a company get a profit by people investing in shares?

In primary market, company gets fund to operate their business but in secondary company gets nothing.

Suppose I invested 1000 INR for 10 shares in your xyz ltd company. You worked hard, putting you sweat & blood and reported a excellent profit with high dividends for very first year. This made your share hiked by 100% to 200 INR per share.

Now I’ve shares of value 2000 (200 per share * 10) but does it means that company got a 100 INR per share in cash?

No, after creation of securities in primary market, shares are just exchanged between investors. It may hiked to 200 or dropped to 10 but company will keep operating with that initial 100 per share (in addition retained earning).

Here how it works…

  • xyz ltd issued shares to A for 100.
  • A retain it for sometime and sold it for 120 to B. (now that difference of 20 is the profit of A, not of company)
  • B sold it for 150 C (difference of 30 is profit of B, not of company)
  • C kept it for a while. Share dropped to 80 so C sold it to A. (that difference of 70 is a loss of C not of company)

Company will keep operating forever, but the shares will keep going from one hand to another.

Book value of company denotes the funds invested and are in operation on current date. Book value comprises of initial amount invested + retained earning.

Current price what people are paying to get that book value price.

In short, company is not profited from investors buying and selling shares in stock exchange (secondary market).

 

  • Debasis

    OMG! Then company may be less bothered about drop of their share prices, when we are in a bad position, loosing our money!!!

    • Of course, they are less bothered but they are affected in a negative way if the price drop – if they had pledged shares then their pledged shares get increases. They lose the opportunity to raise funds again from new issuance…. much more.

  • Sushant Kulkarni

    You fetched 1000 crores by issuing 10 crore shares. Face value 100 INR per share.

    so now after 10 crore, the next person buys 10 shares at current price of 140 say. what does this mean?

    • That’s not “after 10 crores”. The person is just buying the shares from another buyer, not from the company. The amount of shares in the market remains same until and unless company distribute dividends, split shares or initiate a fresh issuance.

  • Jitu Deepak khatri

    very well explained sowmay!!

    so if profit and loss over the span pass on from one person to another ( who buys and sells).

    than how does investor get benefited by quaterly result, company growth, profit and revenue over the period because company will keep operating by initial 100 rupees at the time of IPO, this question came to my mind by below mentioned details extracted from above article :

    “No, after creation of securities in primary market, shares are just exchanged between investors. It may hiked to 200 or dropped to 10 but company will keep operating with that initial 100 per share (in addition retained earning).”