Playing The STOCK MARKET
The hazards of being a pedestrian are many. Of course we have a good chance of crossing paths with a rabid bengal tiger that has highjacked a street cleaner and intends to whitewash every pair of jogging shoes encountered. Or a throng of overzealous religious fanatics might try to slip fresh flowers into our hands and literature into our pockets. And especially when we amble through the financial district, we might be crushed by falling stock market investors who have mistakenly BOUGHT HIGH and SOLD LOW. While the actions of the bengal tiger and overzealous religious fanatics might be understandable, what's so almighty important about the stock market that would make investors place the well-being of innocent pedestrians in jeopardy?
A Source of Instant Wealth?
For many, the words "stock market" bring to mind images of high-powered, wheeling and dealing by the likes of such high-powered, wheeler-dealers as our good Ivy-League friend Winston Smythe Kennsington III. The stock market has a reputation not unlike that of casino gambling in Las Vegas. The dream is that almost any low-life with a few thousand dollars to invest might be able buy the "right" stock just before its price shoots through the roof. Because of the notion of an uncertain future, like we saw with Fact 6, Our Unknown Economy, the risks of investing in the stock market can and do reward some with a big-time payoff. However, it can and does eliminate the bank accounts of others.
I'll have more to say on this idea of instant wealth in wealth and gambling. For the moment, however, let's put aside instant wealth, without totally dashing it against the rocks. Instead, let's ponder the essence of the stock market -- the king of financial markets.
Buying a Corporation
A stock market really has a very simply purpose in life -- to buy and sell ownership shares in corporations, corporate stock. The ownership shares are the "stock" part of the stock market. For example, suppose that over the years Omni Conglomerate, Inc. has issued 100 million shares of stock. If you are the proud owner of one of those 100 million shares, then you own one-hundred millionth of Omni Conglomerate, Inc. You have a legal right to one-hundred millionth of the profit Omni Conglomerate, Inc. makes each year. If they make $100 million in profit this year, then your share is $1.
To see why this is such a big deal, let's consider a few alternatives on the business-side of our economy:
- Proprietorships. This is a business owned and operated by one person -- a proprietor. A proprietor makes all decisions, takes all risks, and gets all rewards. In particular, a proprietor has unlimited liability, meaning there's no legal difference between the business and the person running the business.
- Partnerships. A partnership is like a proprietorship with more than one owner, each sharing the decisions, risks, and rewards. The partners also share unlimited liability, meaning a great deal of trust is needed among partners. If one screws up, everyone pays.
The main problem with proprietorships and partnerships, recognized early on in the industrial revolution, is that neither can be very large. A proprietorship is limited by the wealth one person can accumulate. Partnerships can be somewhat bigger, but that problems of unlimited liability and trust keep them from growing too big.
- Corporations. Our third form of business, the corporation, doesn't have this unlimited liability problem because government considers them and their owners separate legal entities. The owners thus have what is legally termed limited liability, they can lose their investment, but no more. Unlike a partnership, you don't need unwavering trust in each and every single investor when you're part owner of a corporation. This makes it possible to form corporations with thousands, even millions, of owners.
With this corporate-form of business, ownership shares, corporate stocks, can be sold right and left. The means of trading the shares (drum roll please) is the stock market. Or maybe I should say the stock markets, because there are several different markets that trade these ownership shares around. Let's highlight a few.
Big Daddy and the Kids
THE stock market of stock markets in this country and worldwide is the New York Stock Exchange. If you want to get your company's stock into the BIG TIME of stock markets then, you want be listed on the BIG BOARD of the New York Stock Exchange, which is literally located on the famous Wall Street in New York City. This is the stock market that gets most of the publicity when Dan Rather, Tom Brokaw, Peter Jennings, and the other newsguys report financial statistics on the nightly news. The Dow-Jones average is an index of prices of stocks trade on the New York Stock Exchange. The Standard & Poor's 500 is another stock price index from the BIG BOARD.
The American Stock Exchange, with it's progress measured by the AMEX index, is number two on our economy's hit parade of stock markets. We also have the Pacific Stock Exchange that operates on the west coast and the so-called over-the-counter stock transactions through the National Association of Securities Dealers, which you probably hear about in terms of the NASDAQ index. Unlike the other stock markets, where the trading takes place in one location, the over-the-counter trading is through dealers, and their computers, all over the country.
For stock investors with an international flare, virtually all major industrialized nations and a growing number of minor ones, have stock markets. The most widely known, in large part because their importance to the world economy, are the stock markets in Tokyo and London. Even the likes of communist China and the formerly communist Russia have made headway into the stock market arena.
Dividing Up the Assets
It's time to get into the nitty-gritty of how stock markets work and what they mean for pedestrians strolling around the economy.
First, let's dispel a myth. While stock market indexes, like the Dow-Jones average, are often used as indicators of what's happening in the economy, they are NOT the economy. A rise or fall in the stock market does NOT mean our economy -- the economic pie of our production, income, and employment -- is rising and falling.
What, then, do the various stock market price indexes actually mean? The indexes are nothing more than the average price of the stocks traded on their respective stock market. As with any market, stock market prices come about through mutual agreement between buyers and sellers. What, though, are they mutually agreeing on? The simple answer is the value corporate assets.
Let's take an example. Suppose that Omni Conglomerate, Inc. has $10 billion in assets and it has issued 100 million shares of corporate stock. Each share represents one-hundred millionth of $10 billion in assets. In general, then, buyers and sellers should be willing to trade one share of Omni Conglomerate, Inc. for $100, or $10 billion divided by 100 million.
Now, here's where things get a little tricky. What if you, as a potential buyer, expect that Omni Conglomerate is going to do "something extraordinary" in the coming months, such that its asset value will increase by 10 percent. In this case, you would be willing to pay up $110 share. In fact, if you could buy the stock at $105, then you could resell it for $110 when this "extraordinary something" happens, making $5 per share. If you bought 10 gadzillion shares, then you make $50 gadzillion on the deal.
However, if you're not alone in you're expectations, then other buyers, perhaps every other buyer, is willing to do the same thing. The result: The price goes up to $110 per share before anything "extraordinary" actually happens. If the "extraordinary" never happens, then the stock price will likely drop like a rock and "crash" below $100. (If you want to find out more on this, check out speculation in the glossary).
Long Run Health
While there are many short-run ups and downs in stock prices, the bottom line on stock prices is literally the bottom lines. Stock market investors buy and sell based on how productive and profitable they think companies are at the present and, equally important, will be in the future. Of course, individual stock prices depend on what an individual company is doing or planning to do. Good, productive, profitable companies have rising stock prices. Poorly run, unprofitable ones see stock prices fall.
For the entire stock market, however, prices usually (not always, but usually) reflect the health and productivity of our entire economy. Rising stock market indexes, like the Dow-Jones average, indicate that businesses are profitable and that the economy is healthy. Falling indexes suggest the opposite.
Tips on the Stock Market
- I can't resist the temptation to go for the easiest tip: Buy low and sell high. (Whew! I'm glad I got that out of my system.)
- Information is the fuel the stokes the stock market furnace. If you want to be a serious player in the stock market, then you must be willing to invest the time and energy needed to accumulate and stay abreast of all relevant information. The big boys who make a living in the stock market have this information and they'll eat your lunch, breakfast, and midnight snacks, if your information isn't as good.
- If you don't have the information for short-term buying low and selling high, long-run investing is a sound alternative. In that the stock market reflects the long-run prosperity of the economy, you usually can't go wrong by buying stocks and holding them for several years or even decades. That makes the stock market a pretty good place to invest retirement funds.
- Moreover, in that many companies enter and exit the economic scene over the years, the best approach is to diversify -- that is, buy a lot of different stocks. The easiest way to do this is through stock mutual funds.