When you look at the stock market, it’s difficult to understand why each stock is priced in such a way. I mean, look, we all have heard the news that Apple is the first trillion-dollar company, its world’s biggest and most successful company.
Apple’s stock price right now is two hundred fifty-eight dollars, while a company that’s hundreds of times smaller. Like the end of the hour, Inc., had a stock price of three thousand dollars. Does not mean that. And we are incorporated is bigger than Apple. The short answer is no. However, it’s a little bit more complicated than it might seem. In fact, the entire stock price seems quite complicated.
First, look. But there is a logical explanation behind most of the things to make a sense out of the stock market. We have to understand what is a stock in the first place. Let’s say for the last six months you have been thinking of starting a business. The only problem you have is you don’t know what business to start one day on your way to college. An idea strikes your mind. You pull out your phone and write it down. You rush to your house and start planning. Everything looks perfect.
You know how to turn your idea into a multi-billion dollar company. Congrats. But it’s too early to celebrate because you don’t have the capital to start. Gather your family members and you explain to them the idea, hoping that they will invest in the company. Everyone thinks you’re crazy except your uncle who decides to bet on you. Ten thousand dollars in exchange for 20 percent of the company. It may not seem much, but it’s actually a lot because your uncle just valued your idea. That’s not proven yet. At 50 thousand dollars. So you’re just a company, an issue.
A hundred thousand shares and your uncle gets 20000 of them. You start building your website and designing a product. In a few months, you ran out of cash and you need to raise more money. Unlike last time where you simply had an idea. Now you have a concept to present. So instead of going to an uncle again. Now you can do something different, like talking to some of the big guys, such as angel investors, angel investors that are usually the rich dudes who are looking for innovative ideas or young entrepreneurs to invest in something like sharks in the Shark Tank.
It’s not easy to convince these guys to throw money into your business because statistically nine out of 10 businesses fail and you have to prove to them why you are an exception. After talking to multiple angel investors, luckily you could get one of them on board. But first, you have to agree on the valuation. There are a prematch evaluation and post-money valuation. It’s not as difficult as it might sound. Pre Manyi valuation is how you valued the company before receiving the investment and plus money.
The higher the premium valuation, the less portion of the company the investor is going to take. You enter into a negotiation and you can be the investor to throw one million dollars into your business with two million dollars plus money valuation. So the investor is going to take 50 percent of the company and you’ll share will get diluted together with their ankles one. That doesn’t mean you’re going to have fewer shares.
The company will simply issue another hundred thousand shares for the investor. So now there are a total of 200000 shares instead of a hundred thousand shares. And your stake is 40 percent. With a million dollars, you rent in office has some designers, engineers, and specialists to complete your product. Finally, everything is ready. You’re about to launch your product, app service, whatever. But guess what? You’re out of cash and you still need a marketing budget and salespeople.
So you decide to raise some more money. You go for a Series B this time you meet some of these CEOs or venture capitalists. They’re not your typical angel investors. These are dudes with MBA A’s and work in venture capitalists, firms who take other people’s money, and invest in companies such as yours. Anyways, after multiple negotiations, they decide to bet on you since you already have a team and a product to launch your company. Hopefully now worth more. Let’s say the v.C offers you a 10 million dollar investment with a 20 million dollars plus money valuation.
You’ll find that offer fair. And you accepted the company issues another 200000 shares and everyone’s state gets diluted again. Says the B.S. just purchased 50 percent of the company.
In case you’re wondering, no one has lost money so far. In fact, everyone just got wealthier. The angel investor, for example, had 50 percent off to a million dollars when he invested in the company. Now he has 25. Percent of a company worth 20 million dollars. In fact, your stake worth now four million dollars. Anyways you can go for a series C, D, and so one few years has passed. Congrats. You have made it. Your idea turns out to be a success. Your business is finally making money.
Remember, everyone who has invested in your company has been waiting for you to grow big enough so that they can cash out, especially your uncle who’s ten thousand dollar investment now worth millions. You have two options.
You either get sold to one of the giants of the industry like Instagram did, or you go public like Facebook, and that’s known as IPO (Initial public offering) is just another way to raise funds and issue shares. But this time, anyone can buy your shares. They’re open to the public. Your uncle and that angel investor can sell those shares and make a fortune. In fact, people can buy and sell their shares among themselves in the stock market. So before going public, the stock price is determined by what you and the investor would agree on. But after going public, the number of factors that would influence the price slightly change the lows of demand and supply would determine the price.
Facebook went public in May 2012 at thirty-eight dollars per share, valuing the company at a hundred four billion dollars. But the public did not agree with Facebook. So the demand for Facebook shares wasn’t as high as the supply. Therefore, on the day of the IPO, the stock price dropped to eighteen dollars per share.
But Facebook still managed to sell enough shares to raise sixteen billion dollars, making it one of the largest IPO is in the country. The price of the stock price doesn’t accurately present the value of the company because the number of factors that can influence the demand and supply of a certain stock is just too many. Let’s just say hypothetically, some kind of disease would spread around the world that would push the media to talk and exaggerate about how the disease could crush the economy.
That would scare off immature investors and would push them to sell their stocks before the market would go down. As the media said. So the supply of a certain stock, let’s say Facebook, would be much higher than the demand for it in the market, which would push the price to plummet. And that could scare off the rest of the investors and push them to sell their shares as well before it drops even further. Even though this particular disease in any way isn’t affecting Facebook, it’s still forced the stock price to drop significantly. Here is another example.
The company might revise its earnings for the last quarter and they may not meet the expectations slightly. That could get some negative press and negative press could easily push some investors, especially immature ones, to sell their shares. And that would increase the supply of the shares and would drive the price down and even scare off more professional investors. It’s a never-ending cycle. That’s why a panic over a crisis can destroy the economy. The company may not be making a profit for years or decades, but because it seems like some time in the future, it is going to make a lot of money. Investors with key buying shares hoping that one day it’s going to pay back and that hope will keep the price rising, like in the case of Amazon.
It didn’t make a profit for 20 years and it made Bezos the richest man in the world. If a company would keep doing great. The stock price could rise to unbelievable amounts. Berserkers Hathaway stock price picked at three hundred forty thousand dollars a share in February. Yes, you heard that right. A single stock cost three hundred forty thousand dollars. That’s what it takes to invest in Warren Buffet’s company. So some companies play around with their stocks to increase the demand for the stock by splitting their stocks, for example, to keep them attractive, even for small investors. Take an example of Apple. The stock price currently is two hundred forty-seven dollars. But did you know that in June of 2014 it was six hundred fifty dollars? That doesn’t make sense, right?
Because the company doubled its market cap on iPhone sales skyrocketed since then. Then what does that supposed to mean? Let me explain. In June of 2014, Apple split its stocks seven for one. In simple words, Apple divided each stock to seven stocks. So the stock price dropped to ninety-two points seven dollars. So if you had one Apple stock back then, that costs 650 dollars. Now you have seven stocks and each of them cost ninety-two point seven dollars. Nothing really changed.
The stock price seems more affordable now, which increased the demand for them. Hence, the price would rise as well. The number of factors that could influence the stock price is way more than we can possibly cover in this article. But here’s the catch. The trick is to find out if the price of the stock does really represents the true value of the company. If it’s overvalued, it does not worth investing because sooner or later the price of the stock will drop to its real value.
On the other hand, the stock price is lower than what the company really worth. Then it’s a great investment since the stock price. Sooner or later, well, the rise to its real value.