Good morning & happy Monday!
“The intelligent investor is a realist who sells to the optimists and buys from the pessimists.”
– Benjamin Graham, American economist & professor, 1894-1976
The intelligent investor is a realist who sells to the optimists and buys from the pessimists.” – Benjamin Graham, American economist & professor, 1894-1976
So, two weeks ago I addressed the overall topic of what is a stock and what is a bond. Last week we did a deeper dive into bonds and in particular the risks associated with them.
Today, I would like to address stocks, which can be a very complicated topic, but I would like to break it down and make it as simple as possible.
What drives stock prices? How come one day a stock is worth $100 and the next day it can be worth $85? What causes such valuation changes?
The simple answer is where a willing buyer and a willing seller meet.
How much is your house worth? It’s worth what one person is willing to pay for it.
How much is a stock worth? Simply what someone is willing to sell it for and what someone else is willing to pay for it.
The stock market is a trading platform. It’s where buyers and sellers meet to transact stock shares.
Let’s say that I’m interested in purchasing an ownership stake in Southwest Airlines and that the stock is trading for $25 per share. Let’s say I have $5,000 to purchase that stock, that would mean I could buy 200 shares ($25 per share x 200 shares = $5,000).
First of all, why would I want to make such a purchase? One reason and one reason alone: I believe I can profit from such an ownership stake. If I don’t think I will make money, then I would not make the purchase. I think buying at $25 per share is a profitable endeavor.
Now, where would I purchase this stock from? Well, I would have to buy it from someone who is selling it. That means there is someone out there who owns Southwest Airlines stock and thinks that selling it at $25 per share is a good deal for them. Maybe they need the money, maybe they have made some money on the stock and want to cash out their profits, maybe they have lost some money on the stock and they want to cash out with the belief that it will go down further. No matter what the reason, they are willing to sell at $25 and I’m willing to buy at $25.
That’s how the price is set. What will a seller sell it for and what will a buyer buy it for. In this example, that $25 per share price is where we settle. If there are no buyers at $25 then the price will go down. If there are a ton of buyers at $25 then the price will go up.
Now, what if there was an announcement of a major airline crash, what do you think that would do to the price of the stock? Well, I may no longer be willing to pay $25 per share for an ownership stake, I may not be willing to purchase at all, or maybe only be willing to pay $20 per share.
The person on the other end of the transaction (the seller) now will likely not find any buyers at $25 per share. If he/she is going to want to unload that stock position, there will likely be no buyers at $25 share. The market will dictate what buyers are willing to pay and the seller will simply have to decide if he/she is willing to sell at that price point.
This happens in the publicly traded stock market every second of every trading day (9:30am-4:00pm EST Monday-Friday excluding holidays).
Buyers and sellers meet, and the price is determined by what each party is willing to accept.
In this Southwest Airlines example, their average trading volume is around 10 million shares per day. So that means in a “normal day” somewhere around $250,000,000 of Southwest Airlines stock trades hands. That’s just one stock for one day. There are thousands of publicly traded companies transacting simultaneously in the open market. (Just for kicks and giggles: beloved Apple stock 10-day average trading volume is just over 63 million shares per day, with a price point around $180 per share … that means that over $11 billion of Apple stock moves from a seller’s hands to a buyer’s hands every trading day).
The stock market is very efficient in allowing for such easy access for buyers and sellers to meet, but that also means that things can change incredibly quickly.
One headline, Tweet, or rumor can cause a stock to rise or fall almost instantaneously as there are buyers and sellers constantly transacting and ready to buy/sell.
Does the true value of a company really fluctuate so dramatically every day? Probably not, but because buyers and sellers can meet so easily then we can get a minute-by-minute update on a company’s value. This is great for real-time data, but quite problematic if you binge watch CNBC, Fox Business, or Bloomberg as you will probably need some type of medication to calm you down. 😉
At some point, many decades down the road Lord willing, I will be able to sell Intentional Wealth. What’s the value of this business right now? I have no idea. I don’t care because I’m not interested in selling. If/when a sale comes to fruition then a buyer for the business will evaluate the finances, projections, etc. of the business to determine a value. I then as a seller can say yes or no (or I can counteroffer). It will be the fundamentals of the business that will determine the value of the business.
The fundamentals of stock market investing are what really matter. Is this a profitable company? Is the purchase price fair? Is the industry growing? How is their competition? What about government regulation proposals? There are dozens, more like hundreds, of factors that go into deciding what stocks to purchase, hold, and sell. That is where we come in and do our nerdy work. 😉
But all that data crunching, evaluation and analysis is not worth anything if you don’t stick to your plan. Ensuring my clients stick to their plan, even when it’s not easy, is job #1 for me.
I am so incredibly blessed to have such a wonderful client base who understands this, and I can’t tell you how much joy it brings me (and profit it will bring to you) to work with such amazing people!
As we approach the Thanksgiving season, I just want to say THANK YOU for your trust, loyalty, and friendship. You are a true blessing in my life!
As always, please never hesitate to reach out if there is anything we can do to support you.
Make it a great week ahead!