06 Oct 08
I know the basic premise of the stock market -- buy low, sell high -- but I'm unclear what it
actually is. I know that a company goes public and sells portions of itself to investors. But, I'm
unsure exactly how anything happens after that.
Can someone give a brief explanation on the basic principles at work?
Nemesio
06 Oct 08
Originally posted by NemesioYour question is a bit like how long is a piece of string. Investopaedia is worth having a look at. If I want to lose myself in interesting and fascinating detail I tend to lose myself there, the way I also get lost going from one linked wiki article to the next.
I know the basic premise of the stock market -- buy low, sell high -- but I'm unclear what it actually is. I know that a company goes public and sells portions of itself to investors. But, I'm unsure exactly how anything happens after that.
Can someone give a brief explanation on the basic principles at work?
Nemesio
A company reaches a certain size and the person who started it or the group of partners that formed it, work out that if they are ever to really grow into a big concern they had better raise some serious cash to build up some infrastructure and expand into other areas, or simply by up other smaller companies that would typically span the arc of their logistic chain of getting their basic product delivered to market and thus in the process create a really big and hopefully profitable corporation.
SO they get an IPO(initial public offer) going and overnight the company independent of its underlying hard assets has a capitalization value which is the number of shares it has issued multiplied by their offer value.
The whole point is that you the investor would have bought the shares not just hoping for them to go up in value, but because you believe the company has good fundamentals and will continue to grow and perform well as a business, so in a sense you are also betting that they will turn a profit each year and depending on the type of share you purchased, you will get some form of dividend from them. Much like a large cash deposit in the bank generates a yearly interest dividend which if you have enough of a principal amount invested you could get to that threshold of all real wealth dividing lines. And that is having enough money invested so that you could live quite comfortably off only the interest your money/investments generate. If you are filthy stinking rich then a threshold event for you is being able to live large off the interest of your interest. But I digress.
So why does a share price fluctuate? A company constantly publishes reports that indicate its overall financial health and profitability. Hidden in these reports are details and data that financial analysts can extract and evaluate, like the price to earnings ratio.(P/E ratio) This metric is the market value per share divided by the earnings value per share, which is an average value usually calculated over the last 4 quarters. The P/E is a good indicator of how much an investor(the market) is willing to pay for a share.A high P/E value usually suggests that investors are showing confidence in a stocks performance, but people are warned not to be too dependent on this measure because the denominator of this ratio is determined by the company's accounting methodology and can sometimes give an inaccurate picture of the quality of a stock.
Another thing that a company does is forecast its growth and expected profit. The stock price will often move down when profits are announced, which seems odd but really, its investors who are selling off stock on the back of those announcements that drive the share price down. When companies issue profit downgrades stock prices usually fall also.
The recent spiral down trend in the market has occurred mostly over uncertainty over whether certain company's could meet their leveraged
obligations. To make real money its easier to bet on very small rises or falls in the stock price. The only way this can work is to do it with huge volumes of shares. What most investors do is open a margin account that allows them to borrow from their broker to invest more than what they have on deposit. As long as the stock does not fall below a certain predetermined level its all good, and if the price rises enough for the stock to be sold and pay off the interest on the money borrowed then investor A lives another day. The dreaded margin call when the stock does fall below a certain value means either you are forced to top up your margin account with cash you own, or by selling off your position in those shares to pay your broker. If word gets out that you are having difficulties with your margin, its often then that a run on the stock you own could be precipitated by nervous investors which might mean you may even need to sell off more of the stock you own to meet your margin call.
This type of investing(the companies themselves are also doing this alongside ordinary investors) can either be long or short selling. We all understand long selling. You buy low and sell high. On the other hand with short selling you sell stock you 'borrow' and pocket the proceeds. Then because you have to return the stock you 'borrowed' what you are hoping for is that the stock will decrease in price, low enough so that you can buy what you borrowed for less and hopefully pocket a sizeable difference. The bigger the price falls from the moment of selling the borrowed stock, the greater the profit you are likely to make. The pitfalls are that the most you can ever make is 100% on the face value of the stock at the time of purchase, and that would also have required the stock price to collapse to zero. The act of making a large short transaction, might also spook the market into letting the price really tumble and this is the way fortunes can be made in a bear market.
As I said how long is a piece of string, I've only just about warmed up!
06 Oct 08
Originally posted by NemesioBasically, all these publicly traded companies have issued shares of themselves in order to raise capital for one reason or another. All these companies have shares traded in the stock market. The price of these shares is determined entirely by supply and demand. As a general rule, the higher the expectations are of futures earnings, the more demand there is for a companies shares. This increased demand is what raises prices.
I know the basic premise of the stock market -- buy low, sell high -- but I'm unclear what it
actually is. I know that a company goes public and sells portions of itself to investors. But, I'm
unsure exactly how anything happens after that.
Can someone give a brief explanation on the basic principles at work?
Nemesio
The inverse is also true, lower expectations leads to less demand, leads to lower prices. Flooding supply can also lower prices, as it was when the .com bubble burst. (combined witht he wake-up call that these companies will never earn a profit.)
Supply and demand is what changes prices. The reasons for changes in demand are limitless. Typically though, it has to do with expected future prices of those shares, NOT the expected future earnings of the company. This is why share prices do not always track with the companies value as a whole. If the company made more money but the share prices weren't expected to rise, there would be no increased demand. That would likely reduce demand because nobody wants to tie up their money for no profit.
An important point to remember is that stock isn't really 'ownership' of a company. If a company goes out of business, you, the stockholder, get's nothing. You don't get to go in and sell the office furniture or any of the assets. Those who hold the companies debt (bondholders and banks) do.
06 Oct 08
Hrm. I had trouble following kmax's explanation, but I'm going to give it a few more read-throughs
before I ask questions.
I guess what I'm confused about is this:
I'm a company and I decide to go public, so people buy the stock. Let's say each share is worth 10
bucks (who assigns the initial value, the company?) and I sold 1000 shares (or whatever number
makes sense). So, someone just made 10000 bucks. Where does that money go? To me (the
company)?
Then, the price fluctuates based on my performance. Let's say the shares are now valued at
20 bucks (who assigns this value now, the company? some independent agency?). Can the
company buy back its own stock? Does the company ever do that? Why would a company do
that?
I'm totally clueless as to this aspect of our economy and I'd like to understand a little better. I'll
reread kmax's post when I have a little more time this evening and formulate a few more
questions.
Nemesio
06 Oct 08
Originally posted by Nemesiowho assigns the initial value, the company?) and I sold 1000 shares (or whatever number
Hrm. I had trouble following kmax's explanation, but I'm going to give it a few more read-throughs
before I ask questions.
I guess what I'm confused about is this:
I'm a company and I decide to go public, so people buy the stock. Let's say each share is worth 10
bucks (who assigns the initial value, the company?) and I sold 1000 shares (or whate ...[text shortened]... have a little more time this evening and formulate a few more
questions.
Nemesio
makes sense). So, someone just made 10000 bucks. Where does that money go? To me (the
company)?
The price those shares are initally offered at is determined by the broker that structures your IPO (Inital Public Offering) and that money goes to the company.
Your intital share price is determined by the broker handling your IPO. They have a decent idea of what the market is willing to pay for shares of a company like yours. Again, it's all about demand. Prices can get stupid high for companies when demand is stupid high. (Like the .com bubble)
shares are now valued at
20 bucks (who assigns this value now, the company? some independent agency?).
The price of your shares after they are on the market are determined by supply and demand. If your company is doing very well, the demand for your shares will be high causing the price to increase.
There is no central pricing agency. If I want to buy a stock, I have to pay what someone else is willing to sell it for. When you see stock price quotes on TV or in a newspaper, that is the last price that stock was sold for.
Can the
company buy back its own stock? Does the company ever do that? Why would a company do
that?
Yes, a company can buy back their own stock and they often do. There are basically two reasons. 1) They expect the price to go up so they can then sell those shares for a profit and 2) Buying shares back raises share prices by reducing supply. (This makes shareholders happy becuase their shares are now worth more).
06 Oct 08
Originally posted by MerkOkay. So after that initial public offering where the 1000 shares are 10 bucks, if I buy 100
who assigns the initial value, the company?) and I sold 1000 shares (or whatever number
makes sense). So, someone just made 10000 bucks. Where does that money go? To me (the
company)?
The price those shares are initally offered at is determined by the broker that structures your IPO (Inital Public Offering) and that money goes to the company.
...[text shortened]... es by reducing supply. (This makes shareholders happy becuase their shares are now worth more).
shares (1000 bucks), and then sell them for 20 dollars a share (for 2000, thus making 1000),
the company doesn't see any more money than the initial investment, right?
Nemesio
07 Oct 08
Originally posted by NemesioI'm not completely clear on the question, but... I think what you're asking is do they get to keep the profit from the shares they buy back and then resell. the answer is yes.
Okay. So after that initial public offering where the 1000 shares are 10 bucks, if I buy 100
shares (1000 bucks), and then sell them for 20 dollars a share (for 2000, thus making 1000),
the company doesn't see any more money than the initial investment, right?
Nemesio
If Microsoft decides to buy back $500 million worth of shares, they buy them back over a long period (taking that much stock all at once would drive the price way up before you got all your shares) of, lets say, year. Now, lets say a year later Microsoft releases an operating system that doesn't suck and they become more profitable. Their stock prices go up because of it and then they can slowly sell some of those shares they purchase and make a profit on those shares. Again, they can't dump them all at once because it would flood supply and the price would go back down before they could sell them all.
But, if you're not talking about the company buyback, then the answer is no. They don't see any money from the sale of their shares after the IPO (excepting for buybacks as mentioned above). If you buy one hundred shares of a stock (after the IPO) you pay whomever owns the stock and when you sell it, the buyer pays you. The company has no part in those transanctions.
07 Oct 08
Originally posted by NemesioAnd you wouldn't actually make the full 1000. The broker (the companies that process the transactions) charges a few for it. Typically that fee is anywhere from $5 from an online brokerage house or a couple percent from a real live broker.
Okay. So after that initial public offering where the 1000 shares are 10 bucks, if I buy 100
shares (1000 bucks), and then sell them for 20 dollars a share (for 2000, thus making 1000),
the company doesn't see any more money than the initial investment, right?
Nemesio
07 Oct 08
1 edit
Originally posted by MerkI would add that demand does not always relect if a company is doing "well". In fact, what often matters the most is what certain sectors are doing at the time. The stock market is a bit of a fashion show in this regard. For example, before the market crashed commodity stocks were in high demand and if you were a commodity stock that was not doing "well" your stock price would largely be determined by how your peers within that sector were doing rather than on just personal performance.
The price of your shares after they are on the market are determined by supply and demand. If your company is doing very well, the demand for your shares will be high causing the price to increase.
07 Oct 08
Originally posted by MerkGotcha. This is all very helpful. Thanks so much.
I'm not completely clear on the question, but... I think what you're asking is do they get to keep the profit from the shares they buy back and then resell. the answer is yes.
If Microsoft decides to buy back $500 million worth of shares, they buy them back over a long period (taking that much stock all at once would drive the price way up before you got all ...[text shortened]... and when you sell it, the buyer pays you. The company has no part in those transanctions.
I'm now going to reread Kmax's and your first posts and try to digest it.
Thanks to both of you for helping to fill this gaping lacuna in my knowledge.
Nemesio
07 Oct 08
Originally posted by NemesioSo are you about to make the stock market plunge? I have to say that I think it a bit risky to do right now. We have a ways to fall as of yet. 😉
Gotcha. This is all very helpful. Thanks so much.
I'm now going to reread Kmax's and your first posts and try to digest it.
Thanks to both of you for helping to fill this gaping lacuna in my knowledge.
Nemesio
07 Oct 08
Originally posted by whodeyI covered that in my first post. the price is determined by demand for the shares.
I would add that demand does not always relect if a company is doing "well". In fact, what often matters the most is what certain sectors are doing at the time. The stock market is a bit of a fashion show in this regard. For example, before the market crashed commodity stocks were in high demand and if you were a commodity stock that was not doing "well" y ...[text shortened]... ed by how your peers within that sector were doing rather than on just personal performance.
it's an important point though and well worth mentioning again.
07 Oct 08
Originally posted by whodeyNo no no. I have a guy who manages my stocks and mutual funds. My wife
So are you about to make the stock market plunge? I have to say that I think it a bit risky to do right now. We have a ways to fall as of yet. 😉
is more attentive to financial matters than I; I'm a musician, after all.
I'd rather be beaten then try to figure out how to make money in the stock
market.
Nemesio