What in the world is the Stock Market?
Keep It Simple Stupid
So, what are we really trying to say? Well for the most part, we just wanted to give our opinion on relatively new and interesting topics that we figure could be fun and appealing to our fellow millennials. However, quickly enough we learned that talking about some terms, concepts, and even how the markets really work could be confusing sometimes. Also, some of our friends and readers reached back asking for a bit more explanation and this got us thinking. That is why we have created the “What in the world are we talking about?” series. The sole purpose of these issues will be answering any doubts or concerns that you guys have. Well, to the best of our ability. We want to make finance easy and cut to the chase. With no further a due, today we will go over what the market is, how stocks work, and why investors issue stocks. Very simple even basic in principle, but you can get entangled and overwhelmed. And trust me, by the end of this article you will have a clearer view of how the markets work.
Modern stock exchanges make trading easy. You can buy shares, which are also called stocks, through a stockbroker or even online. Investment houses like Morgan Stanley, Merrill Lynch, or Goldman Sachs can connect you with a stockbroker who will trade on behave of you for a fee. Stockbrokers can trade in one of the two main stock exchange markets in the US, which are the New York Stock Exchange (NYSE), and the Nation Association of Securities Dealers (NASDAQ). Stocks that are not listed on any of this exchange markets are sold Over the Counter (OTC). OTC stocks do not meet the requirements of an exchange, but this does not mean that their performance and profitability is bad. It just means that they are generally smaller and riskier companies.
All publicly traded companies need to issue quarterly earnings reports through the Securities and Exchange Commission. The sole purpose of this institution is to keep the checks and balances of these companies, although sometimes they fail miserably. We will cover this topic, as it is fascinating, in the near future. It is highly recommended to visit the sec.gov site and look for the fillings of companies. This is a great source of information and place to start when you want to learn more about a company.
Picture yourself in an investment bank, a trading floor, or looking at the bottom of a financial news broadcast. Have you ever seen those screens with red and green colors moving from left to right? Almost too overwhelming, no? Those mysterious numbers are just market averages designed to give you an idea of how the companies that are being traded are doing in the market. In the US there are three main indexes. The Dow Jones Industrial Average holds the value of the 30 largest American stocks. The S&P500, just like the name says, holds the value of 500 of the largest companies in the US. Now, the NASDAQ Composite holds over 2,800 companies, and this includes both domestic and global companies. These indexes are important because it gives you a general picture of how healthy the market is. This is significant because they act as indicators to learn whether the market is in a bullish or bearish cycle. If the economy is doing well, the normal behavior of the stocks is to rise in mass, and this is called a bull market (and vice versa is called a bearish market). These terms are also use to explain the outlook that the general public and investors have about a certain stock. In our previous articles we have the perfect examples of these situations. While Hernan Lopez had a bearish view (generally pessimistic) of Snap Inc.’s stock Juan Bernardo Pinto had a bullish view of Starbucks’ stock (most likely optimistic). My question to you guys is, would you buy any of these stocks? Maybe short one? First, lets go over what is the stock exchange and how it works.
To put it in simple words, the stock exchange is just a global network that organizes the market, where huge sums of money are moved back and forth. Trillions of dollars are traded every year to buy and sell shares. A share is basically a piece of ownership of a company. When you buy a share you own a fraction of the company’s equity and earnings. The equity of a company are the assets (which include everything a company owns such as buildings, equipment, and trademarks) minus liabilities (everything the company owes) . Earnings are all the money the company makes from selling its products and services. It is important for investors to learn what the earnings of a company are and how they compare to its competitors and the industry’s average. In Wall Street the earnings season is the time where company releases their earnings call. This happens four times a year and the most important number for investors is the Earnings Per Share (EPS), which serves as an indicator of a company’s profitability. It is important to note that before the earnings call analysts issue their estimates, and when the company beats these estimates the stock price usually goes up (and vice versa). As usual analysts are never in consensus, and this is because any forecast is based on assumptions and expectations. Another reason why earnings are important for investors is that growing earnings is generally a good indicator for a healthy company. A company that is growing and outperforming the market will provide solid returns. When a company has excess earnings they might decide to pay dividends. A dividend is a sum of money paid regularly to shareholders, however companies won’t necessarily pay annual dividends. Why? Most new companies are considered growth stocks, which means that they will reinvest all profits to fuel growth and expansion. In this case the value of the company rises as the price of the stock rises, and the price of the stock rises when there are more people willing to buy the stock.
A quick fact to consider about stock prices is that they are not fixed. From the moment the stock is sold to the public its price will fluctuate depending on free market forces. Even a simple rumor can cause a share price to fall fast regardless of the real value of the company. Of course the opposite is quite possible as well, and this is when bubbles can occur. If a particular large number of people buy weak shares because they see great potential their value will rise. Young companies can take advantage of this and see their share price rising even when their sales are not. In the best case scenario the result is growth and in the worst case scenario a economic bubble is formed. And bubbles burst eventually. Over time, the stock price determines the value to shareholders, so the key to investing is buying low and selling high.
Easy enough? Not really. Some companies can literally be tenbaggers (company stocks which value to the investors multiplies by a factor of ten), but odds are most will be disappointments. Investing is a long-term game that requires patience, experience, and strategy, plus a bit of a strong stomach when it comes to taking risky decisions.
From the founder’s perspective, if selling shares means reducing their ownership, why would they issue shares? In three words, “to raise money”. Companies basically raise money in two ways: borrowing money, also called debt financing and equity financing. Equity financing can be accomplished by selling shares to private investors or public investors through an Initial Public Offering. An IPO is the first time a private company sells its stock to the general public. The most important part of raising money is to increase the value of the company. Interestingly enough, the money raised is not correlated to the actual value of the assets or to the company’s current profitability, but on future value of the investment.
At the end of the day the market is a bet and no one can really know how great a company will perform. I don’t care if you are Warren Buffet, Peter Lynch, or Gordon Gekko. Even the big money managers can bet on the wrong horse from time to time. We already mention that investing is a patience game, so if you are in it, be in it for the long run and always remember to cut your losses and take a knee when your investment goes downhill.
We want to end this issue on a positive note and thank our readers and followers for helping us reach more than 180 subscribers on Facebook. If you are not among these people, what are you waiting for? Spread the word, subscribe, and react. We want to hear from you. Please feel free to send us questions, requests, or even topics that you would want us to dig in deeper in the future. Our aim is to keep everything as simple as possible. Also, special thanks and shout out to Abdelrahman “Boudy” El Menshawy and Jawad Shreim for reaching out and making the right suggestions, you guys were the fuel that started this new series in our blog.
If you liked our article, please like and share, help us get millennials to make wise investments and get interested in the stock market. See you next week!
Disclaimer: This article is based purely in our own knowledge, experience, and research. It should not be taken as an expert’s advice for stock picking.
