A Beginner’s Guide to Investing in the Stock Market
Have you ever questioned exactly what the words “stock” and “stock shares” mean? This article will not only answer those questions, but will also provide you with a firm foundation for our “Getting Started in the Stock Market” tutorial. It is intended that our guide will assist you in beginning to become financially independent, and also inspire a deep appreciation for investing that will lead you on the path to a prosperous future. Rewards from investing can be significant, even prompting minimum wage earners to retire with an $8,000,000 fortune. It’s rare, but possible.
Stock and Ownership
What would you do if you wanted to open a store with your family members? If the starting costs of the business are around $100,000, you can divide the ownership of your company to “shares,” which are essentially just pieces of the company. Shares are called as such because you share the profits of the company, proportional to how many stock shares you own. You could charge $100 for each new share of the stock.
If your family members can buy all of the shares, you would end up with the $100,000 needed to start the business. Remember, each person can buy more than one share, and since the shares are priced at $100 each, you need to sell 1,000 shares to equal the $100,000 you need.
If your retail store was to earn $50,000 after all expenses in the first year, your shareholders would be entitled to $50 per share that they own, which is 1/1,000 of your store’s profit. In this case, you would have the option of calling a Board of Director’s meeting (The B.O.D. is a group of people that stockholders collectively chose to make decisions, since it’s hard for a lot of people in a group to run a business) and decide whether to pay cash dividends (payments to the stock holders of their share of the profits, repurchase stock from the shareholders, or reinvest that money in the business.
Eventually, you might decide to sell the shares you own. If the company has grown large enough, you could sell the shares as an initial public offering, or IPO. This would allow you to sell on a stock exchange, which is what happens when you use a stock broker to buy or sell shares. A stock broker is the “middle man” between you and Wall Street, who will match you with an interested buyer (or seller), but takes commissions and/or fees for this service.
If you don’t decide to sell, more shares could be issued and could potentially raise millions of dollars to fund expansion. For example, when Wal-Mart was founded by Sam Walton, the IPO provided the funds to pay off all of his debt and expand Wal-Mart all over the country. The income from selling shares of the Wal-Mart stores helped to create Walton’s private company, Walton Enterprises, LLC. This company possesses the majority of the family’s Wal-Mart shares, and has prompted the family to be one of the wealthiest families in history.
Wall Street is No Different
When you purchase shares of stock, you are also purchasing a small portion of that company. It makes no difference whether you invest in a large, multi-million dollar corporation or a tiny retail store offering its IPO. For example, the McDonalds Corporation once divided into 1,079,186,614 shares of stock. After a year, the company had profited more than 4 billion dollars, so the Board of Directors divided the profit by the outstanding shares, which equaled shares worth $3.87 each. Of that, it was decided to pay out $2.20 per share in dividends, retaining the rest for improvements to the company, such as expansion and debt payments. At the time, McDonalds shares were worth $61.66 each.
So, to put it clearly, the stock market is basically just an auction. People that work for themselves and companies make the decision to purchase shares in an auction in real-time.
For instance, say someone wanted to sell their shares of the McDonald’s stock, and it was priced at $61.66. If there was no one that wanted to buy at that price, the price would need to go down to inspire someone to buy it. If investors believed that the company was going to raise profits quicker than others, they would be willing to make higher bids, so the price of the stock would rise. Stock price is determined, essentially, by supply and demand. There is a fixed amount of shares offered, so when demand for those limited shares rises, so does the price. Correspondingly, if a millionaire investor decided that he wanted to sell all of his shares, it would cause an excess of shares to be released to the market, so supply would overthrow demand, and the prices of shares would decrease.
So, imagine that you bought 1,000 shares of McDonald’s stock, hoping that it would jump in price over the next five years, but the price of each share was cut in half due to the increased supply. You might be upset, but you shouldn’t be, because your theory about the company’s future profits would be correct.
At the close of the market on May 9, 2016, the price of McDonald’s shares was $130.83. Investors are willing to pay more at this time because the management team introduced all-day breakfast and introduced some other ideas that have been successful at raising dividends by increasing company profits. Thanks to the initiatives, McDonald’s corporation pays out around$3.56 per share, which is financed by the $4.80 per share of profits. Even if the scenario is problematic and stock prices plummet to $50 each, your experience, as an owner, is linked to dividends and earning figures.
If the company continues to earn more, sending that extra cash to investors, the value of any daily price doesn’t mean much to long-term owners, unless the situation is extreme. Almost everyone I know owns McDonald’s stock, including myself. None of us worry about the price of the stock on a day to day basis. I am expecting that most, if not all of us will continue to hold onto our shares for 25 years or more, and hopefully purchase more as we invest more money from our careers, businesses, dividends, and other income sources.
Always Keep Perspective on What Stocks Represent
If you were to get upset about the decline of the McDonald’s stock value, you would suffer miserably because of your perception of poor judgment on the management’s part. The price of shares fluctuates wildly as millions of people worldwide decide how much they want to spend, but ultimately, the value of your shares will depend on the company’s profits and subsequently, the amount of dividends sent to you. Throughout your years as an investor, you will see many ups and downs and crashes and rebounds. People around you, as well as businesses and the media, will try to tell you differently, but you should ignore their words. Mathematics is on your side. Basic arithmetic cannot be ignored forever.
How to Decide Which Stocks to Invest In
When you decide that it’s time to begin investing in stock, which would make you a business owner, you should consider a few things first. Specifically, the following questions demand an answer:
What companies are you interested in owning and how will you acquire them?
I have been investing for a long time, so I use owner earnings, which is modified from a free cash flow metric. It helps to determine the safety buffer between how much I pay and the actual, intrinsic value of the stock. When you buy stocks, it’s your job to purchase as many net positive profit values as possible, and adjust for variables such as risk that are specific to your situation.
There are several ways to acquire these shares. In my opinion, the only two approaches that are rational are valuation and systematic acquisitions.
Valuation is what many wealthy investors use, and systematic acquisitions is typically used by inexperienced buyers who aren’t educated about the process but want to receive the benefits of compounding themselves. For instance, Standard and Poor (S&P) typically is the outsourced decision maker of those who don’t want to make purchase decisions themselves. Many asset management service providers offer to pay a licensing fee to use methodology determined by S&P, such as the S&P 500 index. They are hoping to build a portfolio that will reflect the changes in management that the S&P determines are appropriate.
Ultimately, it is your objective to collect an assortment of businesses that spew large amounts of cash that you will be able to use to support your happy lifestyle, fund other investments, donate, or add to your savings.