Introduction to stocks
What it means to buy a company's stock What it means to buy a company's stock
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- Let's talk a little bit about what it means to own shares,
- or stock, in a company.
- I think we all have a general sense.
- But what I want to do in this video is make it a little bit
- more tangible, to really understand exactly what you're
- buying when you buy a share of stock.
- So the general sense, and this is exactly what it really is,
- is when you buy stock or you buy shares you are essentially
- becoming a partial, or part owner, of the company.
- And just to contrast this with bonds, because they are often
- used in the same phrasing, oh I'm going to go buy some
- stocks or bonds, or I deal with stocks and bonds.
- Bonds, you become part lender to the company.
- So for example, if you by a-- well I'll just say a face
- value bond of, let's say it's a thousand dollars, and
- there's a thousand people who do that.
- Each of you all are lending a thousand to the company.
- And since there's a thousand of you, you're lending a
- million dollars to the company.
- And I'm not going to go into detail on that, because the
- focus of this is going to be stock.
- But it's good to keep in mind that they are
- very different things.
- Here you're owning the company, here you're lending
- the company.
- So just to make this a little bit more tangible of exactly
- what we're owning, let me draw a simple balance sheet for
- some company x.
- So this is Company-- let me do a new color-- let's say we're
- dealing with Company x right here.
- And let's say if we looked at Company x's assets, and when
- we talk about assets, it really is the same thing that
- we mean in the real world or in our everyday life when we
- talk about assets.
- They are things that have value.
- Things that are going to give us some
- type of future benefit.
- A house is an asset because it gives us the future benefit of
- being able to live in it and protecting us from cold
- weather and rain.
- Cars are assets because they provide us some
- transportation.
- Cash is an asset because it can be exchanged for things we
- need in the future.
- So all of these-- a loan to someone else is an asset
- because in the future they will pay us back.
- A loan to me is a liability, which we'll
- talk about in a second.
- But anyway, let's just, in the very abstract sense, say this
- is Company x's assets.
- And let's say that they're worth $100 million.
- And I'm not going to go into exactly how this number is
- determined, or who's determining it, or who's
- saying this is a hundred million.
- But let's just say we agree that this is how much their
- land, and their patents, and their copyrights, and their
- cash, and their buildings, and everything else
- they have is worth.
- All of the things that will generate future value.
- Now let's say that Company x has also borrowed some money.
- And maybe they borrowed it by issuing bonds, which I will
- not go into detail on.
- So let's say they borrowed some money.
- And so they owe some people, collectively, $80 million.
- This could have been a straight debt from a bank, or
- this could have been via a bond issue.
- They might have issued-- maybe they issued a million bonds
- where each of those essentially
- represent a debt of $80.
- I won't go into that too much, but I think you get the idea
- what I mean, part lender.
- But this is debt. $80 million of debt right here.
- And let's say that's all of their liabilities.
- There are other liabilities other than debt.
- But for simplicity, let's say that's their only liability,
- and that debt tends to be the biggest.
- Now, what's left for the owners?
- And a good way to think about that is, what would happen if
- this company were sold and the debt paid off?
- So if the company were sold and these assets really are
- able to be sold for $100 million.
- You would get $100 million.
- You'd have to pay the debt holders, you'd have to pay off
- the debt first. So you'd have 100 minus 80, you'd have $20
- million left for the owners.
- I'll do that in this other green color.
- So you'd have $20 million left.
- And this is called the equity, or the owners' equity.
- And this is completely the same idea as when people talk
- about having equity in a house.
- if I have a $300,000 house and I still have $200,000 left on
- the mortgage, then I have $100,000 in equity.
- So it's completely analogous.
- And so you can see very simply that assets-- I'll write this
- down, you're getting a little bit of a introduction to
- accounting right here-- but assets are going to always be
- equal to liabilities plus equity.
- Because essentially, or you can view it this way, if you
- subtract liabilities from both sides, assets minus
- liabilities is equal to equity.
- This might be a little bit more intuitive.
- What we have leftover is always what we own
- minus what we owe.
- That is what the owners have.
- Now, when we say that I'm part owner of our company, that
- means that I have a piece of this pie right here.
- This is what I am a part owner of, the equity.
- So for example, if there are two million shares-- so
- Company x, let's say they have two million shares, and let's
- say that the equity is really worth $20 million.
- How much is each share worth, if we believe
- all of these numbers?
- Well, we have $20 million of equity, divided by two million
- shares which gets us $10 of equity per share.
- So if we believe all of these numbers, and we know that
- Company x has two million shares, then we would say that
- each share is worth $10.
- And if we like these numbers, and if someone is willing to
- sell us a share for less than that, we would buy it.
- If someone was willing to pay more than that, maybe
- we would sell it.
- And just to make all of this a little bit more tangible,
- let's look at an actual example of a company, to show
- you that I'm not making all of this stuff up.
- I got this off of your traditional financial sources.
- This is actually from the filings of
- this unnamed company.
- And you'll get extra bonus points if you figure out what
- this company is.
- And this is their actual stock trading activity.
- And I just want to draw the same diagram that I drew up
- here on this company, so you can kind of see that this
- actually happens in the real world.
- So first let's draw their assets.
- Let's say this is Company x.
- And let's say these are its assets right there.
- Let's go to its balance sheet, this is
- actually what they reported.
- This is June 30, so-- well we want to take the more recent
- date, this is-- they're just trying to compare to what they
- had before-- and let's look at these.
- This is some time ago, but it doesn't matter.
- We're learning.
- We're not trying to decide whether we want to invest in
- this right now.
- This is a very old financial statement.
- But let's just look at what they're saying.
- So they have our total assets here. $30 million-- I'll just
- do in round numbers-- $30 million right there.
- You might be curious about hey, what's all this current
- asset business?
- Those are things that are either cash or that can be
- turned into cash within the next year.
- So, for example, accounts receivable.
- That's money that other maybe vendors owe them that they're
- going to pay very soon.
- Inventories, these are things that they have, maybe in the
- warehouse, that they can sell and turn
- into cash very quickly.
- Other current assets.
- Maybe that's stock or some other type of investment that
- they could sell and turn into cash.
- So they have 18 million of current assets.
- That's things that they can turn into cash very easily and
- very quickly, definitely within the next year.
- And then you have some property, plant and equipment.
- This is kind of that land and buildings and machinery that I
- talked about.
- And then, who knows what these other assets are.
- Maybe those are trademarks or patents or, who
- knows what they are.
- But all in all, they have $30 million of assets.
- Now let's go to the liabilities.
- So they have some current liabilities, $16 million.
- Current liabilities, just so you know, those are
- liabilities-- these are things that they have to pay in cash
- within the next year.
- It could be debt, it could be payables they have to pay some
- other vendors.
- Who knows what it is.
- But you can kind of view it as debt on some level.
- Maybe debt that you have to pay in the next year.
- And then you have long term debt of $5.5 million.
- If you add these two up you get pretty close to about $22
- million, so just for simplicity I'll put it over
- here as $22 million.
- So this company has $22 million in liabilities.
- These are their assets, just to get all
- the labelling right.
- So what's left for equity?
- Well just on this simple diagram we have $8 million
- left for equity.
- And actually, they did the calculation here for us.
- The exact number is $8.39 or $8.4 million in equity.
- But this is a nice round number for us to show it.
- So this is real world stuff that we're dealing with.
- And if you wanted to know, kind of, if you
- believe these numbers.
- If you believe that this company's assets really are
- worth $30 million, what should you pay for it?
- Well, then you're going to divide by the
- total number of shares.
- And you'll see this in some financial statements, and I
- won't go into the details of the difference between basic
- and diluted, but the numbers are very, very close.
- So we don't have to worry about it too much.
- But let's just say that this company has 2.7-- looks like
- 2.78 million shares.
- So if the book value is 8.396-- I mean I wrote eight
- here-- how much should each of these shares-- how much should
- each of these-- and when I say book value, I mean these are
- their books-- according to their books, the equity is
- worth 8.4 million.
- So if we if we really believe that the equity is worth 8.4
- million, how much should each share be worth?
- Well, we'll just divide 8.4 million-- this is actually
- 8.4, I wrote eight there for simplicity-- divided by the
- number shares, 2.78 million.
- So that's a million and that's a million.
- And I'll get a calculator out for this one right here.
- So, let's see, you're doing 8.4 million divided by 2.78
- million shares.
- So if we believe these numbers, if we believe the
- books, the book value of the shares is
- about $3.02 per share.
- So this is $3.02 per share-- book value per share.
- That's what we should be willing to pay for this, or we
- think a fair price per share of this company is, if we take
- these assets are really worth $30 million.
- Now, what are people actually paying for these shares?
- Well, we look at this information right here.
- And we see that the last trade here was for $2.58.
- So people are paying a discount to the number we just
- calculated.
- So the only reason why people are paying less than that, or
- someone's willing to sell for less than $3.00 is that
- someone out there, especially the person selling, thinks
- that this company really-- the assets of this company really
- aren't worth $30 million.
- He or she thinks that the assets of this company are
- worth less than $30 million.
- And maybe they think that the company's prospects aren't as
- good, their product isn't good-- the
- sales are going down.
- Who knows, maybe the person buying it, maybe they think it
- is worth $3.00 a share and that's why they're willing to
- pay $2.58 for it, because they think it's going to go up.
- And just so that we get some of the other details that we
- see here, this bid right here, this is what someone has
- explicitly said that they are willing to pay for a share.
- The ask is what someone has explicitly said they're
- willing to sell a share for.
- This 52 week range is the range of prices that the
- shares have sold.
- So, in the past year, these shares sold for as low as a
- $1.20, and that was actually a great deal because then they
- went up-- even now where they're selling at $2.58.
- The average volume right here, this is the number of shares
- sold per day-- exchanged per day.
- The market cap, right here, you've probably heard that
- word before.
- That's essentially the market's sense of what this
- number really is.
- We're saying that the books of this company are saying this
- company's worth $8 million.
- But the market cap is saying what the equity of the company
- is worth in the market's mind.
- And to get that number, they're taking the $2.58 times
- the number of shares-- times the 2.78 million shares.
- If we do that, we're going to get 2.58 times 2.78 is equal
- to, exactly-- well it's a little different than what
- they had, maybe it's little round off error, but roughly
- $7 million in market cap.
- So like I said before, the market is not paying $3.00,
- it's paying $2.58.
- And so the market is saying that the equity, this piece
- right here, is closer to seven million, even though the books
- are saying that this number right here
- is above eight million.
- Well anyway, hopefully that was a little bit useful and
- gives you a little bit of a sense of what it actually
- means to buy shares in a company.
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