What drives the stock market?
What makes stock prices move?
What even IS a stock?
If you’ve never invested before and you’d love to know the answers to these questions,
then you've definitely landed on the right video
I bought my first stock when I was 14 years old, but I was lucky enough to have a dad
who could explain to me what a stock is and help me learn about investing.
But if you didn’t have someone to teach you this stuff, how else would you know anything
about investing and putting your money to work?
It’s not like they teach us this stuff in school right?
That’s why in this video, I’m going to talk about some of the very very basics of
investing, starting with: WHAT EVEN IS A STOCK?
So let’s just get right into it.
To understand what a stock is, let’s go back in time and do a little history lesson.
The origins of the stock market started way way back in the age of Christopher Columbus,
When a group of enterprising Dutch merchants wanted to send huge ships over to the New World to
start trading spices, silk, and all kinds of other foreign, exotic goods.
This required lots of capital that no single merchant could come up with on their own.
So groups of investors started coming together to pool their money and become co-owners in
these trading companies.
These ventures were called joint-stock companies, and shareholders started buying and selling
their stock with other shareholders and investors.
And thus, the stock market was born!
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The idea was so successful that joint-stock companies started popping up all over Europe.
As the volume of shares and number of companies increased, it became critical to have some sort of organized marketplace
to buy and sell these shares.
So stock traders started meeting up at a London coffeeshop, which became the centralized
marketplace to buy and sell shares.
Eventually, they took over that coffeeshop and changed its name to the "stock exchange."
So that’s how the first stock exchange was born, the London Stock Exchange.
Today, there’s stock exchanges all over the world, with the NYSE and the NASDAQ being
two of the largest and most important exchanges.
OK so that’s it for our little history lesson.
Now you know that a stock is a piece of ownership in a company, and its origins came from the
need to pool money together in order to fund big business ventures.
This concept of pooled ownership in businesses IS what makes it possible to build huge companies
like AAPL, WMT, LUV, and KO.
It takes billions and billions of dollars to build a company like that, and most people
don’t have the money to do it on their own.
Unless you’re Elon Musk.
Elon Musk started Tesla on his own, with $70M of his personal money.
But even Elon Musk eventually brought in outside investors in order to keep scaling the company,
so on June 29, 2010, he did what's called an IPO, or Initial Public Offering.
An IPO is when a private company first starts offering its shares to the public.
Before the IPO, the only way to buy shares in Tesla was to call up Elon Musk….
Hi Elon, it’s me - listen, I want to talk to you about buying a piece of your company.
But now, after the IPO, Tesla’s shares now trade freely on a stock exchange, so anyone
who has a brokerage account can buy stock and become a part-owner in Tesla.
So that’s the difference between shares of private companies and shares of public companies.
You generally can’t buy shares of private companies because there’s no centralized,
standardized place to buy them, but ANYONE can buy shares of public companies easily
and conveniently.
So the stock market is where you can buy and sell shares of these publicly traded companies.
Most companies start out as private companies, and when they get big enough, they can do
an IPO and become publicly traded companies.
Notice that I’m using the words stock and shares interchangeably.
They basically mean the same thing, except that shares are the units of measurement.
So you would say, “I own STOCK in Tesla” or you could be more specific and say “I
own 50 SHARES of Tesla STOCK.”
So now you know that a stock is a piece of ownership in a business, and you know that
the stock market is made up of shares of publicly traded companies.
Now let’s talk about stock prices.
This is what comes up when you Google AAPL.
You can see the stock price right here, and that the market cap is $862B. Market cap is
the total market value of a company's outstanding shares.
So for all the investors out there who own AAPL stock, their shares collectively are
worth $861B at the current stock price of $187.41.
So that means for $187.41, you can become a 0.0000000002% owner in the company.
Or if you’re a big institutional investor and you bought 100M shares of AAPL, then you’d
become a 0.02% owner in AAPL.
To own 0.02% of AAPL means that you own 0.02% of everything the company owns.
It also means you’re entitled to 0.02% of the company’s profits.
So it's all proportional. So the stock price reflects whatever people want to pay at any given moment, to own a slice of AAPL
The stock price is very volatile.
It moves a lot, all the time, 24/7, and movements in stock prices often have nothing to do with
the actual earnings potential of the company.
So I want you to keep that in mind: the stock price is very unpredictable in the short-term,
while the company’s underlying value and earnings potential is much more stable and
predictable.
Let’s quickly go back to the story of our Dutch merchants.
Their trading company is absolutely killing it and they’re making huge profits.
There’s 10 shareholders, which means the profits get split up 10 ways, putting $100K
in each shareholder’s pocket every year.
If one of the shareholders offered to sell you his piece of the company for $100K - would
you do it?
The answer is HELL YES - since each shareholder gets $100k every year, if I buy his piece
of the business for $100k, I’ll make back the purchase price in just ONE YEAR!
Now what if he offered to sell it to you for $1M?
Then I’d have to think about it some more… for $1M it would take 10 years to make back
the purchase price.
And that’s IF the company is still in business for 10 years and nothing bad happens.
The moral of the story is this: The price of a stock is driven by the company’s PROFITS.
Stock prices go up and down because the market thinks profits will go up and down.
Profitability is the foundation of what creates a stock price.
This is how it works in the long-term, but in the short-term sometimes stock prices have
no connection to profits.
For example, right before the dotcom bubble crashed in 2000, there were Internet companies
with no realistic prospects for revenue, but they were trading at sky-high prices.
This happens when market participants who lack knowledge get greedy, and this happens
more often than you think.
I want you to be very aware of this.
Stock prices that have no connection to profits ultimately correct.
It might take a while, and you might even get lucky and make a quick buck or two, but
stock prices always always always come back to true value, which comes from a company’s
profitability.
This goes both ways: if a company’s stock price is too low relative to its profits then
the stock price WILL eventually go back up.
Benjamin Graham, one of the greatest investors of our time, explained this concept in his
book THE INTELLIGENT INVESTOR.
He said that in the short run, the market is like a voting machine - so it’s a popularity
contest between the hot firms and the not-so-hot firms, and it's all depending on the opinions of the general public.
But in the long run, the market is like a weighing machine - it's very precise - and it assesses the real substance
of a company.
So if there’s just ONE thing you take away from this video, let it be this: What drives
stock prices in the long run is a company's actual underlying business performance and
not the public's emotional opinions about the company in the short run.
For more beginner-friendly info on stock investing, make sure you also check out these 2 videos here.
And if you’re new to the channel, hit that subscribe button for more awesome videos every week!
Always remember to go after your dreams unapologetically, and to live life on your terms - cheers!