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Studying for a test? Prepare with these 10 lessons on Stocks and bonds.
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Voiceover: Let's talk a little bit about what it means to own shares or stock in a company, so shares or stock. 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 essentially becoming a partial or a part owner of the company. Part owner of company. Just to contrast this with bonds because they're often kind of used in the same phrasing, "Oh, I'm gonna 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 you buy a, well, I'll just say a face value bond of, let's say, it's $10. Let's say it's $1,000, and there's 1,000 people who do that. Each of you all are lending $1,000 to the company and since there's 1,000 of you, you're lending $1 million to the company. I'm not going to go into detail in 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 to 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. The 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 give, provide us some transportation. Cash is an asset because it can be exchanged for things we need in the future. 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. Let's say that they're worth $100 million. $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 100 million, but let's just say this is, 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. Let's say they borrowed some money, and so they owe some people collectively $80 million. $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 of what I mean of part lender, but this is debt. $80 million 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 debt tends to be the biggest. Now, what's left for the owners? 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 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. $20 million left, and this is called the equity, or the owner's equity. Owner's equity. 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. It's completely analogous. You can see, very simply, that assets. I'll write this down. You're getting a little bit of an 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 a 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 we have, if there are 2 million shares, so Company X, let's say they have 2 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, 20 million of equity divided by 2 million shares, divided by 2 million shares, which gets us $10 of equity per share. If we believe all of these numbers, and we know that Company X has 2 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. 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, the same diagram that I drew up here, to really, 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. Its assets. Let's go to its balance sheet. This is actually what they reported. This is June 30th, well, we want to take the more recent date. They're just trying to compare to what they had before. 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. They have our total assets here. 30 million, I'll just do in round numbers. $30 million 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 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. 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. 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. Then the 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. 22 million liabilities. These are their assets, just to get all the labeling right. So what's left for equity? We'll just draw it on this simple diagram. We have 8 million left for equity. 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. 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 8 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. If we really believe that the equity's worth 8.4 million, how much should each share be worth? Well, we'll just divide 8.4 million, we'll just have to divide 8.4 million, 8.4 million. This is actually an 8.4. I wrote 8 there for simpicity. Divided by the number of 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, we're here doing 8.4 million divided by 2.78 million shares. So according, 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 what we think a fair price per share of this company is if we think these assets are really worth $30 million. Now, what are people actually paying for these shares? Well, that's, 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, 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 of the assets of this company are worth less than $30 million, and maybe they think that the company's prospects aren't as good. They're product isn't, the sales are going to go down. Who knows? Maybe the person buying it, maybe they think it is worth $3 a share, and that's why they're willing to pay $2.58 for it because they think it's going to go up. Just so that we get 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 that the shares have sold, so in the past year, these shares sold for as low as $1.20, and that was actually a great deal because 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 is 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. 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, let's see, 2.58 times 2.78 is equal to exactly, well, it's a little different than what they had. Maybe it's a little round-off error, but roughly 7 million in market cap. Like I said before, the market is not paying $3. It's paying $2.58, and so the market is saying that the equity, this piece right here is closer to 7 million, even though the books are saying that this number right here is above 8 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.