What's a stock actually worth? Part 1.
An incredibly reasonable mistake that investors make is giving too much weight to the share price of a company.
When a company goes public, it decides to raise money from investors (like you) to fuel its growth –– and in turn, you then own a portion of that company (and a claim to its potential profits) going forward.
The company makes a mostly arbitrary decision: how many tiny, ephemeral shares of our company do we want to create out of thin air?
If their company is worth $5,000,000, and they choose to create 100,000 shares, then their price-per-share will be $50 each.
This decision around how many shares to create, in all its randomness and non-importance, drives so many everyday conversations around stocks:
· Do you think I should sell my Tesla stock @ $1,100 a share?
· I'm going to buy Apple stock if it gets cheaper and hits $155 a share!
Unfortunately, in isolation, price-per-share is completely useless in determining the value of a company. If we only know the cost of a slice of a pie, but haven't been told how many slices exist, how can we possibly determine the price of the whole pie?
I prefer huckleberry, but bear with me:
Same pie, different number of slices.
Same total value...but certainly a different price-per-share.
In our everyday transactions, it's not difficult to assess value. You can pay this amount for that product.
$1 for a soda. $20 for a t-shirt. $600 for a scooter. Heck, $12 for a whole pie.
These prices are helpful to guide decision-making; the product is the whole pie…what's being offered, entirely, and what it costs. There are no slices of a scooter.
But with stocks…these share prices are unhelpful (in isolation) because you aren't discussing the entire pie. Price-per-share is arbitrary, but necessary.
Recall that the goal is for the company to sell people pie slices (shares) of its pie. Actual examples:
Tesla is split into roughly 1 billion shares. Random.
Apple is split into about 17 billion shares. Also random.
If share prices, standing alone, don't matter, how can we actually start to think about what the value of a company is?
You don't need an education in finance to take the next step: if you know the price per slice, and you know how many slices exist, you can multiply them together to get the price of the whole pie. Voila.
Finding the price-per-share is rather easy –– that's what carnival barkers on financial TV yell about, and how people talk about stocks at cocktail parties.
Like $37.10/share for AMC, below:
It's what's in the business pages of a newspaper, or your phone's stock app.
$932.57/share for Tesla, below:
As such, by fiddling with how many slices exist, unglamorous companies can actually have high share prices, and fabulous companies can actually have low share prices. Here's an example:
Allegiant costs $176.72/share
Delta costs $36.56/share
Allegiant is a cut rate airline. Delta is Delta.
Delta is a much more valuable company than Allegiant, it just happens to have a lower price-per-share. Here's why:
Allegiant randomly has 16,000,000 shares
Delta randomly has 636,000,000 shares
A company's market capitalization (aka market cap) is the price of the whole pie, and this is what matters. If somehow you lived in a frictionless world, and had the money to do so, it's literally the cost to buy the entire company yourself. Here are some market cap examples (derived simply from just price-per-share x shares):
~ Market Cap
Price Per Share
The Bank of Chile
Nathan's Hot Dogs
If you've ever wondered why people often say that picking stocks is hard –– it's because the order and magnitude of differences in the market cap column above should seem somewhat reasonable. That's the sign of a generally well-functioning market.
The spreads between great companies with high market caps, and less great companies with lower market caps, are intended to make you feel somewhat indifferent between them as investment opportunities...for example:
Invest $1,000 in Apple
Invest $1,000 in Nathan's Hot Dogs
Why? How? Apple is clearly a much better company!
Apple is a better company, but you've got to pay more for that ownership.
$1,000 in Apple buys you 0.0000000357% ownership stake...
...while $1,000 in Nathan's Hot Dogs buys you .0004% ownership stake.
Each of those percentages is just your $1,000 divided by company market cap (i.e. slice divided by pie).
For $257,000,000 -- you can own .0092% of the entire company, Apple. A teeny fractional slice of an enormous, amazing company with sleek, elegant tech products.
OR...you can buy the entirety of Nathan's Hot Dogs, and be a Fourth of July hero.
The market's job is to allow buyers and sellers to transact, and thereby setting prices (market caps) so that this decision of where to put your $1,000 is challenging.
Research shows that it does a great job of this; on average, people who try to pick stocks have an abysmal track record.
It's easy to say that Apple is a better company than Nathan's Hot Dogs, but it's much harder to decide which is a better investment. The price of the pie matters.
But for some reason people still like talking in price-per-share, which tells us nothing.
End of Part 1.