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“Successful Investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.”
– Warren Buffett
Here is a quick lesson on the stock market for those readers looking for the basics before we dive into the action steps.
The stock market has a very low barrier of entry. Almost anyone can own a publicly traded company’s stock and potentially grow their own investment account. Actively trading and investing in a successful company’s stocks helps to diversify your ability to create income instead of selling your time for money at a job.
Companies raise money when they go public by selling their stock on the stock market through an Initial Public Offering. If a company has an IPO for 1 million shares offered at $20 a share, then they will take in $20 million if the market buys all their stock at the offering price. Once a company takes in the money from their initial share of stock through the IPO, their shares trade on the open market and the price is determined by what investors and traders are willing to pay for the stock at any given time. The value of a company is set by the price of the stock multiplied by the number of shares of the stock that were issued. If a company has 1 million shares of stock and the price of the stock is $100 per share, the company market capitalization is $100 million, meaning the company is worth $100 million.
The company doesn’t determine the value of its stock, the market does. The price of a stock is set by the last traded share price, because the stock market is essentially an auction where there is a ‘bid’ and an ‘ask’ price at any given time. The ‘bid’ is what someone is willing to buy the stock for, and the ‘ask’ is what someone is willing to sell the stock at. When the stock is physically traded, that becomes the stock price.
The company is separated from the buying and selling of its own stock unless it issues a stock buyback program. During a buyback, a company will go on the open market and buy its own shares and lower the share float available for trading and investing. Share float is the actual number of stocks available for trading at any one time.
A company can also issue dividend payments to reward investors with a share of company earnings. Dividends are usually paid four times a year (quarterly) on stocks. A dividend stock’s yield is determined by the amount of their annual dividend payments divided by their current stock price. If a company pays four annual dividends a year at $1 each for $4 in total annual dividends, and the stock price is $100, then the stock’s yield is 4%.
Additionally, the company could also have a secondary offering of stock to raise additional capital, but this brings more supply into the market and dilutes the existing shares. A secondary offering is looked at negatively because it shows the company needs to raise more capital because it doesn’t have adequate cash flow inside the business to operate.
As mentioned above, the company can also buy back its existing shares and lower the amount of shares available in the market. A buyback program provides support for a stock price and takes supply of shares out of the market, helping to increase the demand for the stock. Stock buybacks are looked at as a positive sign, because it shows the investors that the company believes that its best use of extra capital is to buy back its own stock.
This is the basics of how companies are related to their stocks. The company and the stock itself are two different things. The stock market can be both a wealth building and wealth destroying machine. It goes through cycles of long term uptrends (Secular Bull Markets) and long term downtrends (Secular Bear Markets) that can last for years.
The stock market can also experience short term bubbles like the dot com era of the late nineties into March of 2000, when earnings and sales expectations for the next decade were already priced into stocks and reality hit investors hard. Likewise, it can have short term corrections with prices dropping 10%, short term bear markets when prices drop 20%, and even crashes when the market as a whole can plunge 50%, like late 2008 and early 2009.
The stock market is not the Holy Grail of riches where all you do is buy stocks and win. The stock market is a game of survivorship. Some post IPO stocks go on to rise by 1,000% over the next decade and eventually end up in the Dow Jones Industrial Average as leaders of an industry. Others stock values may lose half their value in six months, eventually being delisted as the underlying company goes bankrupt.
The stock market is a reflection of free market capitalism with both winners and losers. The leaders in the U.S. stock market have reflected advances in technology, and the stock market is the mechanism for participating in the growth of the modern economy.
Your ability to use the stock market as a wealth building tool will be based on how well you can consistently do things that expose your money to good opportunities and uptrends in the stock market as a whole, and in individual stocks that are going up in price as their sales and earnings rise. When you have captured some nice trends, your next job is to know when to exit with profits and not allow them to be taken back during the next bear market, or when the company makes a misstep and loses its competitive advantage.
There is a time to be in the stock market and a time to be out. This book will be help you maximize your chances of making money long term, while minimizing your financial and emotional risk.