How shares are created — IPOs, ownership, dividends

Yesterday we defined what a stock is. Today we cover where shares come from in the first place — and the second hidden return stream most beginners never count.

THE IPO MECHANICALLY

An Initial Public Offering is the first time a private company sells shares to the public. The mechanics are not glamorous.

Step 1: the company hires investment banks (Goldman, Morgan Stanley, JPMorgan) as underwriters. The underwriters do due diligence on the business, help write the prospectus (the S-1 filing in the U.S.), and gauge investor demand.

Step 2: the underwriters do a roadshow — meeting with large institutional investors (pension funds, mutual funds, sovereign wealth funds) to take orders. By the time IPO day arrives, the underwriters generally know which institutions want to buy how many shares at roughly what price.

Step 3: the night before the IPO, the underwriters set the offering price — the price at which the company will actually sell its shares to those institutional buyers. The offering price is set just below where the underwriters think the stock will open trading the next morning, so the institutions get a small built-in profit. (This is one of the reasons institutions make money on IPOs and retail traders often don't.)

Step 4: the next morning, the stock begins trading on a public exchange. The offering price might have been $24, but the opening trade is $32 — set by where buy and sell orders match in the open market. By the time you, the retail trader, can buy a single share, you're buying it at $32 (or whatever level the open trading produces). The institutions who got allocations the night before at $24 are sitting on an instant 33% gain.

This isn't a conspiracy — it's just how the IPO process works structurally. Underwriters need to underprice the offering to ensure institutional demand. The retail trader is, by design, downstream of that.

WHY THE FIRST WEEKS ARE TREACHEROUS

Three things compress into the first weeks after an IPO that make them dangerous for retail buyers:

The lockup period restricts insiders (founders, employees, early investors) from selling for typically 90 to 180 days. When the lockup expires, a flood of insider supply hits the market. The stock often drops on lockup expiration regardless of how good the business is, because the supply curve shifts.

Pricing discovery in the first weeks is genuine chaos. The market doesn't know what the stock is worth yet — there's no history of trading volume, no chart pattern, no earnings reports under public scrutiny. The price swings can be 20% in a day on no real news.

No "base" has formed. In the chart-pattern work we'll do in Month 4, you'll learn that growth stocks tend to move in stair-steps: a sharp advance, a quiet consolidation (the "base"), and then another sharp advance off the base. Newly-IPO'd stocks haven't had time to form the consolidation pattern yet. Buying without a base is buying without a known floor.

For these three reasons, we generally avoid buying within the first 5–10 trading days of any IPO. We'll cover IPO base patterns in detail in Month 9 — there's a specific setup that emerges around 6–9 months post-IPO that has produced some of the great winners of the last 25 years.

DIVIDENDS — THE SILENT RETURN STREAM

Now the second part of today's lesson. When you own a share of stock, you might also receive dividends — quarterly cash payments the company sends to shareholders out of its profits.

Not every company pays dividends. Growth-stage companies (think Amazon for most of its history, or Tesla) typically reinvest all profits into the business and pay no dividend. Mature companies (Coca-Cola, Procter & Gamble, Johnson & Johnson) typically pay 2–4% of their share price annually as dividends.

Here's why dividends matter even if you only think about share price:

The S&P 500's total return is about 10% per year over the long run. But the price of the index has risen at only about 7% per year. The other 3% comes from dividends — paid out, often reinvested into more shares, and compounding over time.

If you bought $1,000 of an S&P 500 index fund in 1995 and sold in 2025, the price-only return would have multiplied your money by about 7×. The total return including reinvested dividends would have multiplied it by about 12×.

That difference — 5× more money — is dividends. They are not a small detail. They are roughly a third of the total return of the U.S. stock market over the long run.

"The most powerful force in the universe is compound interest. Dividends, reinvested, are how you turn that force on for yourself."

Albert Einstein (frequently attributed; the exact source is debated, but the math is correct)

THE QUIET TWIN: BUYBACKS

There is one more way companies return capital to shareholders, and it has overtaken dividends as the dominant method since about 2000: share buybacks.

When a company has excess cash, instead of paying it out as a dividend, it can use the cash to buy back its own shares from the market. This shrinks the total number of shares outstanding. Each remaining share now represents a slightly larger ownership claim on the business — so even if the business itself doesn't grow, each share's claim is worth slightly more.

Buybacks have one big advantage over dividends: they're tax-deferred. A dividend is taxed in the year you receive it. A buyback raises the price of your shares, but you don't owe any tax until you sell.

Apple has spent over $700 billion buying back its own shares since 2012. That isn't accounting noise. That is the dominant way Apple has returned value to shareholders during one of the most successful 13-year stretches in corporate history.

When you read a company's quarterly report, look at three numbers: net income, dividends paid, and shares repurchased. The last two — combined — tell you how much capital the business is returning to its owners.