Good morning & happy Monday!
In the short run, the market is a voting machine. But in the long run, it is a weighing machine.
Benjamin Graham, economist, professor, investor (1894-1976)
Last week’s Monday morning memo discussed how supply and demand are the forces behind the prices we pay, be it filling up our tank, taking a flight or buying a computer.
Today I would like to discuss how the same supply and demand principal is at work in how the price of stocks and bonds are determined.
I know the stock market seems overwhelming and oftentimes seems to make no sense, but if you break it down it really comes down to supply and demand, just like the price of your lunch.
If you decide to buy a stock and price of the stock is $50/share, why is that the price of that stock? Because that is what buyers and sellers have determined it to be.
Let’s break this down to more simple terms to understand what is happening at a huge scale.
Let’s say a company is worth $1,000,000 and there are 20,000 shares outstanding. That would put the price per share at $50 ($1,000,000 value divided by 20,000 shares). Let’s say I own 2,000 shares of this company, a 10% ownership stake, and I would like to increase my ownership stake to 15% by purchasing 1,000 more shares. How would I go about acquiring the other 1,000 shares? I would have to buy them from other people who own them. Obviously, that means someone would have to be willing to sell them to me.
If the business is doing amazing the shareholders might not be willing to sell their shares to me for $50/share, they might demand $55 or $60 or $70 per share. If I’m willing to pay no more than $60 a share and the lowest offer someone is willing to take is $65/share then I simply won’t make the purchase. Going back to last weeks conversation, in this example the supply is constant (same 20,000 shares in the company) but the demand (the price point a willing buyer and a willing seller meet at) is what varies.
I might only be willing to pay a max of $60/share today but a month from now I might be willing to pay $65/share.
The stock market is nothing more than a place for buyers and sellers to meet and they determine what the companies (and thus stock price) are worth based on what they are willing to pay to own them and willing to accept to sell them.
If you call me with instructions to take $10,000 from your bank account and invest it into your portfolio, then I am placing the orders to buys shares from other people who are selling them.
Same vise versa. If you call me and tell me to sell $10,000 from your investments and deposit into your bank account, I am placing the order to sell your investments to someone is who looking to buy them.
From 9:30am-4:00pm EST Monday-Friday (except holidays) this is what’s happening in the stock market … buyers and sellers are meeting and the price of any given security is determined by what the buyers are willing to pay and what sellers are willing to sell for. Except the scale is huge in comparison to my example.
Just for kicks and giggles, on April 12, 2022 Apple’s stock volume was over 77 million shares (source: www.investing.com). That means that 77,144,304 shares of Apple stock traded hands on that single day at a price point between $166.64 – $169.87 … that’s roughly $13 billion ($13,000,000,000) went from one investor to another in one stock in one day.
We operate in the space of marketable securities, a marketable security means that there is virtually always a buyer and always a seller … it’s just a matter of at what price they agree upon.
I know a good many of you are not interested in learning ‘how the sausage is made,’ but if there is some interest in how stocks are priced, I hope this over simplified explanation was valuable.
It is an honor to serve you. Make it a great week 😊