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Current time:0:00Total duration:11:55

Video transcript

I've had enough requests by now for videos on investing that I thought I would make some videos on investing investing and the way I'm going to go about it is over the next few videos I'm gonna give people the vocabulary of at least how do you think about investing and and what are the 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 they not apply and then we're gonna use those tools later on and then hopefully we'll look at some particular companies and my goal you know it isn't to do what they do on CNBC and you know tell you buy buy buy and sell sell sell because frankly you'll you know it that's not a 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 you know through the videos we'll come to conclusions but I don't want to I don't want to be too strong about them because if I'm wrong I don't want you to lose your your 401 K so the first thing that that I guess you could say bugs me a little bit is I go to these family gatherings and you know some uncle or or aunt will come up to me and says hey you know I just made a killing I bought Citibank it's so cheap it's only I don't know what it was at the time it was only $1 it's a cheap stock as opposed to and you know implicitly there there's the assumption that a 10 dollar stock would be expensive and I think this is very obvious to you but let me let me write that down so price per share price per share and 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 dollar stock 10 dollar stock let's call the stock a stock a and stock B and I think this is very obvious to anyone hopefully who spent any time investing or thought about what what a stock even represents but you'd be surprised I've had you know family members who are doctors and engineers tell me this so I thought it's it's a good place to start to clarify any confusion so my question to you is is something that is one dollar is that cheap relative to something that is $10 in the everyday world it is if if I could buy an Apple for $1 that's cheaper than an apple that cost $10 or any good really but what 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 for example if I have one company and actually maybe add this 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 dollars that's its assets all its buildings and its employees and its brand it's worth 1 million dollars let's say and I'm going to 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 of these terms will hopefully get very familiar worth over the course of these videos but let's say its assets are worth a million dollars it has no liabilities so all of its equity that the asset value is all in equity so this is all equity sometimes called stockholders equity and the equity is really just what 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 owned all $1,000,000 if if you believe that this is really worth 1 million dollars now you could have this scenario let me actually draw the same scenario over again let me copy and paste this let me copy and paste that so this is these are two equivalent companies completely equivalent companies but this company over here they might have decided to detect I don't know they might have decided to have 10 shares it's about a draughty one two three four five six seven eight nine ten I think that's ten ships well that's my intention they have ten shares so what is the value per share right each share in this case once again if you believe that the assets are worth a million dollars are going to be a million dollars and the equity is a million dollars cuz it represents there's no debt so all of the assets are are held by the equity holders so each share would be worth a million divided by 10 which is equal to one hundred thousand dollars obviously you never see a hundred thousand dollar shares out there at least not not not in in 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 ten shares it's a hundred thousand and let's say this company writes it right now right here so we know a hundred thousand 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 just you know really so they have times 1 million shares so in this situation the company is worth what it's worth or the shares are worth what they're worth 1 million divided by 1 million shares or $1 per share so going back to the idea when my you know family member would come to me to 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 us you know just just to just to get in the game you got to put up a hundred thousand dollars to buy a share let's say this stock trades down and it's trading at fifty thousand dollars right it's trading at fifty thousand dollars and their assets are identical so this is you know 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 dollars 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 of assets is essentially what is the market saying the assets are worth the book value of the assets is where what the accountants within the company are saying the assets are worth and and there's a there's a whole methodology to how one would account for that but this is the market value of the asset and I already told you that these assets are identical they generate the same earnings 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 $1,000,000 for the same asset I don't care what the actual share price is this is what you're valuing it at so the person who says that $1.00 here is cheap relative to $50,000 here and they might even say well they're the same company and I get it here for $1 a share and I get it there for 50,000 dollars a share this is the 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 for one tenth of this company so this one is actually the better deal so in general when you're trying to just figure out relative price of a company and we're gonna talk a lot more about ratios and how do you know if something is inherently cheap 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 for 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 that's very I guess the it's there's a lot of frictions and investing in penny stocks because obviously if you have a $10 stock a 10 dollar stock could go from ten dollars to ten dollars and one cent or could go to $9.99 and this is what this is only a 0.1% move right but if you have a let's say you have a penny stock let's you have a stock that's at five cents it can't move it can only move by a penny one in one direction before I was actually it was actually in eighths so if you move only by a penny you could only go to a six to six cents or you could go to four cents and so in either direction you're looking at a 20 percent move while here you're looking at a one 1000th move or point one percent 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 you're kind of you know there's 20 percent changes 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 a hundred thousand dollars that makes it difficult for people to buy even one share but that's that's the only place where price matters inherently when you're talking about value you have to take the the price per share and you multiply it times the number of shares number of shares so these stockings 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 because this is very different let me see let me erase that so if in this example let me actually erase more let me erase this as well all right so in this example what'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 you kind of have to need it that's a good starting point just to get a sense of what the company is all about so let's say that this company has 10 million shares 10 million and this company right here has I don't know let's say it has 500,000 shares 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 market let me write that down market sometimes called the market cap market capitalization capital is Asian market capitalization and you multi and it's essentially just what what is the market saying the equity is worth right and in this case or I went off the screen in this case where you don't have debt they're actually saying with what is the asset worth so if I took this one one dollar per share times a million ten million shares the market is saying this company is worth 10 million dollars or that the equity of this company's worth 10 million dollars in this case they're saying $10 per share times 500,000 shares they're saying it's worth 5 million dollars that's the market capitalization of the company that's what the cup the that that this is what people are saying the company is worth and actually I'm running out of time from there so the next video will talk a little bit about well how does how do people actually determine what something is worth and and that obviously can be a infinitely deep discussion but we'll try to get get our feet wet a little bit see you soon