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Video transcript
I've had enough requests by now for videos on investing, that I thought I would make some videos on investing. And the way I'm going to go about it is, over the next few videos, I'm going to give people the vocabulary of at least how do you think about investing? And what are the terms and the ratios people use? And why do they make sense? Or why do they not make sense? And when do they apply? And when do they not apply? And then we're going to use those tools later on, and then hopefully we'll look at some particular companies. And my goal isn't to do what they do on CNBC and tell you, buy, buy, buy, and sell, sell, sell. Because frankly that's not a thoughtful way of going about things. What I want to do is really give you the tools to come to the conclusions yourself. And maybe through the videos, we'll come to conclusions. But I don't want to be too strong about them, because if I'm wrong I don't want you to lose your 401(k). So the first thing that I guess you could say bugs me a little bit, is I go to these family gatherings, and some uncle or aunt will come up to me and says, hey I just made a killing. I bought Citibank. It's so cheap. I don't know what it was at the time, but it's only $1. It's a cheap stock. As opposed to implicitly there, there's the assumption that a $10 stock would be expensive. And I think this is very obvious to you, but let me write that down. So price per share. So when someone tells me that a $1 stock is expensive, they're implicitly saying, well that's just because it's a low number, as opposed to, say, a $10 stock. Let's call this Stock A. And Stock B. And I think this is very obvious to anyone hopefully who's spent any time investing, or thought about what a stock even represents. But you'd be surprised. I've had family members who are doctors and engineers tell me this. So I thought it's a good place to start, to clarify any confusion. So my question to you is, is something that is $1, is that cheap relative to something that is $10. In the everyday world it is. If I could buy an apple for $1, that's cheaper than an apple that costs $10, or any good, really. And the twist here is that a share is just a share. It doesn't somehow represent the entire company. It's a fraction of the company. It's just a share. And all companies don't have the same amount of shares. For example, if I have one company-- and actually maybe that's a good point to introduce a balance sheet-- let's say one company whose assets, because I want to do this throughout our discussion. Whose assets are worth, let's say, $1 million. That's its assets. All its buildings and its employees and its brand. It's worth $1 million. Let's say it doesn't have any debt. And we'll introduce debt later, because that's another variable that a lot of people don't think about when they look at stocks. They just look purely at the equity value or the market capitalization. And all these terms we'll hopefully get very familiar with over the course of these videos. But let's say its assets are worth $1 million. It has no liabilities. So the asset value is all in equity. So this is all equity. Sometimes called stockholders' equity. And the equity is really, the people who own the company. what is their stake? So in this case, they never borrowed any money to buy these assets. So the owners of the company own all $1 million, if you believe that this is really worth $1 million. Now you could have this scenario. Let me actually draw the same scenario over again. Let me copy and paste this. soon. So these are two equivalent companies. Completely equivalent companies. But this company over here, they might have decided to have 10 shares. So if I were to draw that, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10. I think that's 10 shares. Well that's my intention. They have 10 shares. So what is the value per share? Each share in this case-- once again, if you believe that the assets are worth $1 million-- are going to be $1 million. And the equity's $1 million, because there's no debt, so all of the assets are held by the equity holders. So each share would be worth $1 million divided by 10, which is equal to $100,000. Obviously you never see $100,000 shares out there, or at least not in the great majority of examples. So this is a bit of an artificial example. More likely a company might have a million shares, in which case this would be a $1 stock. But anyway, this is a case where they only have 10 shares. It's $100,000. Now let's say this company right here says, well $100,000, that's kind of a crazy number for a share price. It'll keep a lot of people from buying our shares. So let's just divide it into a million shares. So they have times one million shares. So in this situation, the company is worth what? Or the shares are worth what? They're worth $1 million divided by one million shares, or $1 per share. So going back to the idea where my family member would come to me at a party, they would say oh, look how cheap this company is compared to this company. Even more, let's say for whatever reason, because not so many people could afford this stock, because just to get in the game, you've gotta put up $100,000 to buy a share. Let's say this stock trades down, and it's trading at $50,000. And their assets are identical. So obviously there's no two companies that are identical in this way, but let's say that they are. Let's say in both cases the assets of this company are worth the exact same thing as the assets of that company. So here investors are valuing this company at $1 times a million shares. They're valuing these assets at $1 million. In this case, the investor is saying, OK, I'm willing to pay $50,000 per share. And there's only 10 shares. So they're valuing the assets at $500,000. And this is of course the market value of the assets. And we'll talk more about market versus book value of assets. But the market value or assets is essentially, what is the market saying the assets are worth? The book value of the assets, or what the accountants within the company are saying the assets are worth. And there's a whole methodology to how one would account for that. But this is the market value of the assets. And I already told you that these assets are identical. They generate the same earning stream with the exact same risk. So in this situation, you're paying $500,000 for the same asset that over here you're paying $1 for. I don't care what the actual share price is. This is what you're valuing it at. So the person who says that $1 here is cheap, relative to $50,000 here. And they might even say, oh well they're the same company. And I get it here for $1 a share, and I get it there for $50,000 a share, this is a cheap company. But that's completely 180 degrees in the wrong direction wrong. Because you're actually paying more for this company. You're paying $1 for one millionth of this company, while you're paying $50,000 dollars for one tenth of this company. So this one is actually the better deal. So in general, when you're trying to figure out relative price of a company-- and we're going to talk a lot more about ratios and how do you know if something is inherently cheap, you relative to its earnings or what it could earn, or its growth or anything like that-- but the first cut is, you can't just look at the price. The price is almost a meaningless number. It matters to some degree for trading purposes. Where a lot of institutional funds won't look at a stock that's below $5. A lot of stocks that go into the penny stocks. There's a lot of frictions in investing in penny stocks, because obviously if you have a $10 stock, a $10 stock could go from $10 to $10.01. Or if could go to $9.99. And this is only a 0.1% move. But let's say you have a penny stock. Let's say you have a stock that's at $0.05, it can only move by a penny in one direction. And before it was actually an eighth. So if you move only by a penny you can only go to $0.06 or you could go to $0.04. And so in either direction you're looking at a 20% move, while here you're looking at a 1/1000th move or a 0.1% move. So that's one reason why price might matter a little bit here. There's huge frictions if you were to buy and sell, there's 20% every time. And we'll talk about things like bid-ask spreads and liquidity and things like that in the future. But that's where the price really starts to matter. And obviously if you have a really huge price, like $100,000, that makes it difficult for people to buy even one share. But that's the only place where price matters. Inherently, when you're talking about value, you have to take the price per share and you multiply it times the number of shares. So these Stock A and Stock B, these are different than the ones I drew down here. So let me draw a little dividing line right there. And let me erase some of this. So if in this example-- let me actually erase more. So in this example, it's important to write down the number of shares you have. And you could look this up on Yahoo Finance. And we'll do this in the future with a bunch of companies. We'll just go through the motions of figuring out all of the metrics. Just because that's a good starting point just to get a sense of what the company's all about. So let's say that this company has ten million shares. And this company right here has 500,000 shares. So what you do is you multiply these numbers to figure out, what is the market value or the market capitalization of the company? So that's a word. Let me write that down. Sometimes called the market cap. Market capitalization. And it's essentially, what is the market saying the equity is worth? In this case where you don't have debt, they're actually saying what is the asset worth? So if I took this, $1 per share times 10 million shares. The market is saying, this company's worth $10 million. Or that the equity of this company's worth $10 million. In this case, they're saying $10 per share times 500,000 shares. They're saying it's worth $5 million. That's the market capitalization of the company. That's what the people are saying the company is worth. And actually I'm running out of time from there. So in the next video we'll talk a little bit about how do people actually determine what something is worth? And that obviously can be an infinitely deep discussion. But we'll try to get our feet wet a little bit. See