Wednesday, September 28, 2011
How stocks in the stock market work.
Let's say there is a video game store owned by Jared who has owned it for the last 10 years. Let's say we want to buy Jared's video game store so that everyone will buy the video games from us instead of Jared.
To find out how much the store is actually worth, we have to find out how much Jared is making. If the store is making $200 a day, that means it is making around $6000 a month. That is about $66,000 a year. So if the video game store makes that much for the next 10 years, it would be worth around $660,000.
This is simply to figure out how much money the store will make in a certain period of time. We don't have to do all this stuff, there are companies that do this for us. They just tell us how much the store is worth and we decide to buy it or not.
Let's say Jared's video game store is worth $660,000. If we want to buy it, we give him $660,000 and the store is ours. Now what if we don't have that much money? What if we only have half of that($330,000). We can give him that half to own 50% of the company. Which means we get 50% of the profits. So if Jared makes $200 a day. We would be getting $100 a day. We could also buy 10% for $66,000 and make $20 a day. Or 1% and so on.
Sometimes companies sell shares of stock. So if Jared wanted to sell 100 stocks then those stocks would be $6,600 at 1% each. If you own 1 stock that is worth 1%, that means if Jared's video game store makes $100, you would make $1. If you wanted to buy all 100 it would cost $660,000 and you would own 100%. Bigger companies that are worth millions and billions sell more stocks at lower prices. If they only sold 100 stocks it would be too expensive and no one would buy it. So they can sell 1000 stocks at $660 each or 10000 at $66 each. Some companies have millions of stocks.
People who buy stocks are called "investors" and the act of buying shares is called "investing". That means the investor thinks that the company will make a lot of money in the future and the investor can turn a profit.
When you buy shares in a company, you just don't get the money that they make. You also get to make decisions in the company. These are called "shareholder meetings". Everyone who owns a share will get to vote on what the company will do next. If you own more shares, your vote will count more.
Let's say there are 4 people voting. George, Sarah, Bill, and Daniel. Now George, Sarah, and Bill vote for option A. While Daniel votes for option B. George, Sarah, and Bill own 20% of the shares each, while Daniel owns 40%. The combined percentage for option A is 60% while the percentage of votes for option B is 40%. That means that option A is the winner. Even though Daniel has more shares than them seperately, he will still get out voted by all of them together.
Now if one person owns more than half the shares, then they have what is called "controlling interest" in the company. Which means they make all the decisions.
For a more detailed and in depth explanation on the stock market, I suggest you read The Intelligent Investor: The Definitive Book on Value Investing.