If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:13:47
MEA‑3 (EU)
MEA‑3.A (LO)
MEA‑3.A.1 (EK)
MEA‑3.A.2 (EK)

Video transcript

let's talk a little bit about what it means to own shares or stock in a company shares or stock and 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're you're essentially becoming a partial or part owner of the company part owner of company and just to contrast this with bonds because they're often kind of used in the same phrasing oh I'm going to go buy some stocks or bonds or I deal with stocks and bonds bonds bonds you become part lender to the company part lender to the company so for example if if you buy a allowed to say a face value bond of let's say it's ten dollars say it's a thousand dollars and there's a thousand people who do that each of you all are lending a thousand dollars 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're very different things here you're owning the company here you're lending the company so just to get 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 company X right here and let's say if we looked at company X's assets and 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 there 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 in protecting us from cold weather and rain cars are assets because they give provide us some transportation cash is an asset because it can be exchanged for things we need in the future so all of these alone to someone else is an asset because the future they will pay us back alone to me is a liability which we'll talk about in a second but anyway let me 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 dollars 100 million dollars 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 100 million but does just say this is we agree that this is how much their land and their patents and their copyrights and their cash and and 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 eighty million dollars eighty million dollars this could have been with 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 are 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 eighty million dollars of debt right here 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 a hundred million dollars you get a hundred million dollars you'd have to pay the debt holders you'd have to pay off the debt first so you'd have 100 minus eighty you'd have 20 million dollars left for the owners I'll do that in this other green color so you'd have 20 million dollars left 20 million dollars left and this is called the equity or the owners equity owners owner's equity this is completely the same ideas when people talk about having equity in a house if I have a three hundred thousand dollar 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 left over 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'm I have a piece of this pie right here this is what I am a part owner of the equity so for example if we have if there are two million shares so company X let's say they have two million two million shares so and let's say that the equity is really worth 20 million dollars how much is each share worth if we believe all of these numbers well we have 20 million dollars of equity 20 million of equity of equity divided by 2 million shares divided by 2 million shares which gets us $10 $10 of equity of equity per share so if we believe all of these numbers then and we 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 the 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 that their actual stock trading activity and I just want to draw the same diagram that I drew up here the same diagram that I drew up here to really on this company so you can kind of see that this is actually happens in the real world so first let's draw their assets let's draw this let's say that this is company X and let's say this these are its assets right there its assets let's go to its balance sheet this is actually what they reported this is June 30th so well I want to take the more recent date this is you know 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 this is 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 dollars right there so 30 million 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 Oh 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 stock or some other type of investment that they could sell and turn into cash so they have 18 million of current and current assets that's things that they can turn into cash very easily and very quickly definitely within the next year then you have some property plant and equipment this is kind of that land and buildings and and and machinery that I talked about and then who knows what these other assets are maybe those are trademarks or patents or or who knows what they are but all in all they have thirty million dollars of assets now let's go to the liabilities so they have some they have some current liabilities sixteen 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 may be debt that you have to pay in the next year and then they have a long-term debt of five and a half million if you add these two up you get pretty close to about twenty twenty two million so just for simplicity I'll put it over here is twenty two million so this company has 22 million in liabilities 22 liabilities these are their assets just to get all the labeling right so what's left for equity well just draw on this simple diagram we have eight million left for equity eight million left for equity and actually they did the calculation here for us the exact number is eight point three nine or eight point four 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 thirty million dollars 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 do worry about it too much but let's just say that this company has 2.7 looks like 2.7 8 million shares so if the book value is eight point three nine six 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 that means this is these are their books according to their books the equity is worth eight point four million so if we if we really believe that the equity is worth eight point four million how much should each share worth be worth well we'll just divide eight point four million we'll just have to divide eight point four million eight point four million this is actually an eight point four I wrote eight there for simplicity divided by the number of shares two point seven eight 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 say we are doing eight point four million divided by two point seven eight million shares so according if we believe these numbers if we believe the books the book value of the shares is about three three dollars to cents per share so this is three dollars three dollars and two cents per share book value per share that's what we should be willing to pay for this or what we think fair price per share of this company is if we think these assets are really worth 30 million dollars now what are people actually paying for these shares well that's we go we look at these this this information right here and we see that the last trade here was for two dollars and fifty eight 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 three dollars 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 there their product isn't good the the sales are going to go down who knows maybe the person buying it maybe they think it is worth three dollars a share and that's why they're willing to pay two dollars 58 for it because they think it's going to go up and just so that we get you know some of the other details that we see here this bid this bid right here this is what someone has explicitly said that they're 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 at the shares of social so in the past year these shares sold for lis as low as $1 20 and that was actually a great deal because then they went up well you know even now or they're selling at $2 58 the average volume right here this is 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 markets sense of what this number really is we're saying that the books of this company are saying this company is worth eight million dollars but the market cap is saying what the equity of the company is worth in the markets mind and to get that number they're taking the 2.58 they're taking the 2.58 times the number of shares times the two point seven eight million shares and if we do that we're going to get c2 point five eight times two point seven eight is equal to exactly well it's a little different than what they had maybe it's a little round off ever but rough seven million in market cap so like I said before the market is not paying three dollars it's paying two dollars and fifty eight 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 actually what it actually means to buy shares and a company