Shared Knowledge

"Investing - Stock Markets"

Summary: Investing in stocks are risky but have a place in a portfolio were return beyond simple municipal bond (muni) rate-of-return (ROI) is desired.

The Good Story:

The story for owning stocks is a good one. Someone has a bright idea and builds a product or service and initially attracts money from private investors. If the product or service is successful, the company adds additional services or products and expands in terms of manufacturing capability and/or knowledgeable personnel until it reaches a point where it needs a massive influx of money and issues stock via an initial public offering (IPO). If you are lucky and have connections, you might be able to buy stock in a company at their IPO. If you were lucky, you might have bought shares in Google or Apple and if you held onto your investment all this time, you small investment could be worth millions. Thus the core idea behind stocks is that company you buy is going to do well in the future and make lots of profit and you will get to share in their success as the price of their stock will rise.

Most do not have the opportunity to buy shares in a company at its initial IPO and thus you must use buy shares via a stock market.

Stock markets are where buyers and sellers meet. After an IPO, all shares traded in a company are done via a stock market where the seller and buyer agree to a price. In actuality, the actual mechanism of a stock market, determines the price of a stock for sale, adding on a small commission to handle the trade.

Problems:

Stocks rise in value really only one reason: investors "think or believe" that the company's products or services will continue to be competitive and the company will make a profit and expand. Underlying this "belief" could be: changes in tax codes; new product offerings, the loss of competition, expansion of markets, etc. But the point to make here is that "it is only belief" that the company will continue to succeed and make profit.

Stock price and book value.  The problem with the price of any stock you can buy is that there is too much "belief" built in. When a company begins, he must build or acquire manufacturing facilities; rent, buy or build office space; etc, etc. The valve of tangible assets of a company are known as its "book value", meaning if the company had to be liquidated for whatever reason, the book value would be the total sum of company asset sales. But the stock of most companies trade a multiples of their book value! This means, should the company have to be liquidated, you might received pennies of every dollar you invested or perhaps even nothing.