Primer on stock prices and markets
This is me trying to recount what I learned about stock prices a few days ago. I’ll do it into a primer for a 5 year old.
I’ll also assume this 5 year old knows or at least wants to know more of what a stock market is, and what it has to do with the value of a company.
The value of a company, put simply, is calculated by multiplying the value of it’s shares by the number of outstanding stock. Pay close attention to the two terms I highlighted.
The first one was all my inquiry was about. The second one I’ll explain first.
A company is usually owned by several people, organizations too. Let’s call these entities shareholders. Shareholders as the name suggest, own a particular amount of shares in the company. So let’s say the company was divided into one million parts or shares and a particular entity owns 500,000 of those shares. You would say the entity owns 50% of the company.
So to own some part of the company you need to buy their shares. And the purchase of these shares are done at market value. That is, if the market says a company’s stock or share is worth $10 per unit, it is at the market price that an intending shareholder would buy. Take note again of that term because the value of a company’s stock has little to do with how much the company wants to sell it but what the market is willing to pay for it.
How is this market price then set? Glossing over it, I’ll do like what every other blog does and say it is determined by the forces of demand and supply. But, if anything, that only made me want to know more. More of it’s technicality, not some theory.
I’m assuming you know what a stock market is, but for clarification and simplicity, we’ll say it’s a building where people go to buy stock they are interested in. Likewise, people who want to sell stock also go here to meet potential buyers.
This market has an opening and closing time. You can only, technically, buy and sell stock when the market is open. But you can make pre-orders for stock, pending the time when the market opens.
Let’s start from the time a company makes it possible for people to trade it’s stock, this is called an IPO, Initial Public Offering. This is almost like the one time a company has the ability to put a price on it’s stock.
Let’s make a company up and bring it to it’s IPO. Numbers Inc. is announcing it’s IPO and creating 1 million shares at $20 per piece. This values the company at 20 million dollars. Now, I want to buy into Numbers Inc. but I don’t think it’s worth $20 so I offer $15. Another bloke (just for imitation of an actual market) offers $25.
This is where the market comes in and say, alright, let’s come to an agreement and decide to sell it for the average of all the offers received against the stated amount sellers (a single one now, the company) is willing to sell. An aggregate amount is reached and the stock market announces that value as the price of a unit of stock in that company. Everyone trades at that value, selling and buying.
In reality, we’d have hundreds, if not thousands buying and selling at the same time. And the market price changing steadily too, typically 3 seconds, I would say. And the stock market, I would assume too, uses more complex calculations to arrive at a market value.
Simulate that exercise over thousands of traders and over multiple times per second. Hundreds of entities stating desired buy amounts, and sellers staying theirs too. In it’s way, the value of a company’s stock is determined by how much people are willing to buy it and how much others are willing to let it go.
That’s it, Johnny. The stock market is not so complicated, is it?
