What is the purpose of a Stock Exchange ?

It seems with the daily barrage of news, forecasts, predictions and commentaries by pundits, professionals and "sooth-sayers", perhaps no one has really realized the purpose of having a stock exchange in the first place ! The way the newspapers and publications go about it, you would not be blamed for mistaking the stock market as some national lottery game or gambling den, or even some fast-paced high-octane game where "The Winner Takes It All" (as ABBA sang it so succinctly some 30 years ago).

Nothing could be further from the truth though. The stock exchange's true purpose is for purely business reasons and it is merely one method which companies can use to raise funds for business expansion. Let's examine the main reasons in more detail:-

1) Private Companies sell shares to the public to raise funds for business expansion, using the stock exchange as a platform. They thus become "public" or "listed" companies from then on.

The main purpose of the stock market is to let aspiring companies sell shares to the general public in order to raise funds to expand their business. These are also known as "Initial Public Offerings" or IPO. A company needs to have some track record usually (3 years of consecutive revenue and profit growth) as well as fulfill several other conditions before it is allowed to list. Note that this is just ONE of the methods which a company can utilize to raise funds, others will include bank borrowings or issuance of debentures (bonds or notes) which are a form of debt. Listing on an exchange is a way of raising funds through equity, and it involves an expansion of a company's share capital. In a way, one can argue that it dilutes the stakes of existing owners but it also makes the company's shares liquid, thereby ascribing a market value to them almost as soon as the shares begin to trade.

2) Secondary Offering - Additional funds raised through a secondary offering of shares using the stock exchange as a medium

Even after being listed, companies can utilize the stock exchange (called the "capital markets") to issue more shares to raise even more funds for future business expansion, assuming there are buyers to take up the additional shares. This is known as a secondary offering and is most popular when share prices are HIGH, therefore this method is very common during a bull market. When share prices are high, companies can raise higher amounts of money through the issuance of less shares, thereby raising more capital with less dilution to existing shareholders. Notice now in the current bear market, no company is using a secondary offering to raise funds ? At the most, we hear of companies doing rights issues which ensures proportional participation in the company's fund raising and ownership.

3) A listing status may raise the profile of companies which may enable them to widen their scope of business expansion and get better recognition from suppliers/banks.

An intangible benefit of being listed (on the Singapore Stock Exchange at least) is that it confers to companies a certain status which is recognized by suppliers, customers, banks and other stakeholders. Knowing that the requirements for being listed are pretty stringent, this would imply that the company has "what it takes" to make it as a listed entity, and thus it would accorded a fair amount of respect. This would enable it to raise its profile and use its listed status as a "marketing" tool to reach out to more potential customers and to expand its business. Of course, one must also recognize that the quality of listing aspirants drops drastically as the market goes on a bull run, up to the point where the quality of those listed just at the apex of the bull market really gets very questionable ! I won't pinpoint names but suffice to say that certain China companies (S-Shares) fall under this dubious category.

4) A stock exchange gives the intelligent investor the opportunity to be a part-owner of companies.

This is the part I love best about the stock exchange. Aside from the hullabaloo and nonsense being spouted daily about the stock market and whether it is going up or down, the intelligent investor need only be concerned about one thing - the ownership of good companies at reasonable prices for the long-term. The stock exchange is a medium which makes this possible, as it allows sellers and buyers to transact. Without this medium, investors would not be able to partake in the profits and growth of companies (which is actually partaking in the growth of a slice of the economy). Provided one researches companies well and does not overpay for a piece of a wonderful business, one can enjoy many good long years of fabulous returns (much higher than the bank FD rate, trust me !) with little or no risk. One may argue that blue chips are a sure way of achieving this, but be aware that in the current economic crisis, the USA has proven that even blue chips may not be that "blue" after all and can be prone to total collapse (like AIG, Fannie Mae, Lehman Brothers). Thus, it is always prudent to do a thorough analysis of any investment before purchasing it, whether it is small-cap, mid-cap or blue chip.

And so I hope that the rationale for a stock exchange has been adequately explained in the above 4 points. Anyone who has more to add, please feel free to use the comments box or to discuss/debate over the 4 points which I brought up.