How did the stocks business start? - February 04, 2018

How did the stocks business start?

Buying stocks is one of the most obvious ways of investing. Even if you have a diversified portfolio (which we always advise), there’s a great chance that stocks have a huge share in it. But how did stocks come to exist? It’s an interesting story that started more than 400 years ago.

The reason for issuing stocks at the beginning was a bit different than it is now. It wasn’t simply a way of expanding a business and looking for capital but more of a way for merchants to gather financial resources for risky expeditions from others.

How did modern stocks start?

Although the history of stocks dates back as far as the Roman Republic and they can be found throughout the history, the general agreement is that the first modern stock exchange was in Amsterdam in the 1600s. In 1602, the Dutch East India Company was created by former competing merchants and was given full control over Asian trade. This meant huge power for them over many things (they even had the right for their own armaments and defences), but trading with far away countries was rather expensive and risky at that time.

Since they wanted to share these costs and risks of trading with others, they started to sell shares and paid dividends on them. With these stocks they were able to raise funds for expeditions and in exchange they shared their profits. Other companies did this before them, but they are considered to be the first multinational megacorporation. To do this, they also created the Amsterdam Stock Exchange which had its own building just after 9 years it was established. This is considered to be the start of modern stock exchanges and it exists in the present as part of Euronext.

Bubbles came soon after

Financial bubbles are almost as old as stocks. Since the Dutch East India Company was great investment in its time, others wanted success like theirs. Many similar companies were looking for investors in the same way. The main difference was that Dutch East India Company really had a prospering business, while others didn’t. This lead to the first bubbles.

An early bubble burst in France, but probably the most well-known example was the South Sea Bubble of Great Britain. South Sea Company had monopoly over South American trading. Based on the promise of trading, they sold their shares. But South American trade was controlled by the Spanish and Great Britain was in war with them: the company had no real chance of realizing any business in that area. This also meant that their return promises weren’t backed up by any real business. Still, their shares flew high until its investors lost their faith in the company and started to sell their shares. The market crashed, or to put it another way, the bubble burst.

How do modern stocks do?

After seeing the South Sea Bubble, authorities soon started to fight against the phenomenon, making stocks more secure. Nowadays, before a company can release shares, authorities inspect its financial state. Even after shares are sold, a company has to publish its quarterly results to inform its investors. This means that creating these classical bubbles is much harder in modern markets, therefore stocks are considered to be a stable investment, especially if someone has a diversified portfolio.

Still, at the time of an Initial Public Offering (IPO), stocks can have higher risks. This is when companies seek capital to expand, much like it was at the time of the first stocks. The risk is connected to these companies’ generally young age: it’s hard to predict how they perform and how their prices will change after the IPO. Amazon and Facebook had stellar results while Twitter and Snapchat had mediocre success just to name a few IPOs from the last decades. Later in a stock’s life, such risks are smaller or different. Prices can change rapidly, but that is rare and even if a multinational corporation’s stocks fall, they usually slowly go back up, just as it happened to Volkswagen in the last years. After the financial crisis of the last decade, several analysts found that stocks recovered much faster than real estate for example.

To sum it up, the most important thing hasn’t changed in the last 400 years: the long-term success of a stock is closely connected to the success of the company itself.

Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.