i've had enough requests by nowfor videos on investing, that i thought i would makesome videos on investing. and the way i'm going to goabout it is, over the next few videos, i'm going to give peoplethe vocabulary of at least how do you thinkabout investing?
share value of apple, and what are the terms andthe ratios people use? and why do they make sense? or why do they not make sense? and when do they apply?
and when do they not apply? and then we're going to usethose tools later on, and then hopefully we'll look at someparticular companies. and my goal isn't to do whatthey do on cnbc and tell you, buy, buy, buy, andsell, sell, sell. because frankly that'snot a thoughtful way of going about things. what i want to do is really giveyou the tools to come to the conclusions yourself.
and maybe through the videos,we'll come to conclusions. but i don't want to be toostrong about them, because if i'm wrong i don't want youto lose your 401(k). so the first thing that i guessyou could say bugs me a little bit, is i go to thesefamily gatherings, and some uncle or aunt will comeup to me and says, hey i just made a killing. i bought citibank. it's so cheap.
i don't know what it was at thetime, but it's only $1. it's a cheap stock. as opposed to implicitly there,there's the assumption that a $10 stock wouldbe expensive. and i think this is very obviousto you, but let me write that down. so price per share. so when someone tells me thata $1 stock is expensive, they're implicitly saying, wellthat's just because it's
a low number, as opposedto, say, a $10 stock. let's call this stock a. and stock b. and i think this is very obviousto anyone hopefully who's spent any time investing,or thought about what a stock even represents. but you'd be surprised. i've had family memberswho are doctors and engineers tell me this.
so i thought it's a goodplace to start, to clarify any confusion. so my question to you is, issomething that is $1, is that cheap relative to somethingthat is $10. in the everyday world it is. if i could buy an apple for$1, that's cheaper than an apple that costs $10,or any good, really. and the twist here is thata share is just a share. it doesn't somehow representthe entire company.
it's a fraction ofthe company. it's just a share. and all companies don't havethe same amount of shares. for example, if i have onecompany-- and actually maybe that's a good point to introducea balance sheet-- let's say one company whoseassets, because i want to do this throughout ourdiscussion. whose assets are worth,let's say, $1 million. that's its assets.
all its buildings and itsemployees and its brand. it's worth $1 million. let's say it doesn'thave any debt. and we'll introduce debt later,because that's another variable that a lot of peopledon't think about when they look at stocks. they just look purely at theequity value or the market capitalization. and all these terms we'llhopefully get very familiar
with over the courseof these videos. but let's say its assetsare worth $1 million. it has no liabilities. so the asset valueis all in equity. so this is all equity. sometimes called stockholders'equity. and the equity is really, thepeople who own the company. what is their stake? so in this case, they neverborrowed any money to buy
these assets. so the owners of the companyown all $1 million, if you believe that this is reallyworth $1 million. now you could havethis scenario. let me actually draw the samescenario over again. let me copy and paste this. soon. so these are two equivalentcompanies. completely equivalentcompanies.
but this company over here,they might have decided to have 10 shares. so if i were to draw that, 1,2, 3, 4, 5, 6, 7, 8, 9, 10. i think that's 10 shares. well that's my intention. they have 10 shares. so what is the valueper share? each share in this case-- onceagain, if you believe that the assets are worth $1 million--are going to be $1 million.
and the equity's $1 million,because there's no debt, so all of the assets are heldby the equity holders. so each share would be worth$1 million divided by 10, which is equal to $100,000. obviously you never see $100,000shares out there, or at least not in the greatmajority of examples. so this is a bit of anartificial example. more likely a company mighthave a million shares, in which case this wouldbe a $1 stock.
but anyway, this isa case where they only have 10 shares. it's $100,000. now let's say this companyright here says, well $100,000, that'skind of a crazy number for a share price. it'll keep a lot of peoplefrom buying our shares. so let's just divide itinto a million shares. so they have times onemillion shares.
so in this situation, thecompany is worth what? or the shares are worth what? they're worth $1 million dividedby one million shares, or $1 per share. so going back to the idea wheremy family member would come to me at a party, theywould say oh, look how cheap this company is comparedto this company. even more, let's say forwhatever reason, because not so many people could afford thisstock, because just to
get in the game, you'vegotta put up $100,000 to buy a share. let's say this stocktrades down, and it's trading at $50,000. and their assetsare identical. so obviously there's no twocompanies that are identical in this way, but let'ssay that they are. let's say in both cases theassets of this company are worth the exact same thing asthe assets of that company.
so here investors are valuingthis company at $1 times a million shares. they're valuing these assetsat $1 million. in this case, the investor issaying, ok, i'm willing to pay $50,000 per share. and there's only 10 shares. so they're valuing theassets at $500,000. and this is of course the marketvalue of the assets. and we'll talk more aboutmarket versus
book value of assets. but the market value or assetsis essentially, what is the market saying the assetsare worth? the book value of the assets, orwhat the accountants within the company are sayingthe assets are worth. and there's a whole methodologyto how one would account for that. but this is the marketvalue of the assets. and i already told you thatthese assets are identical.
they generate the sameearning stream with the exact same risk. so in this situation, you'repaying $500,000 for the same asset that over here you'repaying $1 for. i don't care what the actualshare price is. this is what you'revaluing it at. so the person who says that $1here is cheap, relative to $50,000 here. and they might even say, oh wellthey're the same company.
and i get it here for $1 ashare, and i get it there for $50,000 a share, thisis a cheap company. but that's completely180 degrees in the wrong direction wrong. because you're actually payingmore for this company. you're paying $1 for onemillionth of this company, while you're paying $50,000dollars for one tenth of this company. so this one is actuallythe better deal.
so in general, when you'retrying to figure out relative price of a company-- and we'regoing to talk a lot more about ratios and how do you know ifsomething is inherently cheap, you relative to its earnings orwhat it could earn, or its growth or anything like that--but the first cut is, you can't just look at the price. the price is almost ameaningless number. it matters to some degreefor trading purposes. where a lot of institutionalfunds won't look at a stock
that's below $5. a lot of stocks that gointo the penny stocks. there's a lot of frictions ininvesting in penny stocks, because obviously if you have a$10 stock, a $10 stock could go from $10 to $10.01. or if could go to $9.99. and this is only a 0.1% move. but let's say you havea penny stock. let's say you have a stockthat's at $0.05, it can only
move by a penny inone direction. and before it was actuallyan eighth. so if you move only by a pennyyou can only go to $0.06 or you could go to $0.04. and so in either directionyou're looking at a 20% move, while here you're looking at a1/1000th move or a 0.1% move. so that's one reason whyprice might matter a little bit here. there's huge frictions if youwere to buy and sell, there's
20% every time. and we'll talk about thingslike bid-ask spreads and liquidity and things likethat in the future. but that's where the pricereally starts to matter. and obviously if you have areally huge price, like $100,000, that makes itdifficult for people to buy even one share. but that's the only placewhere price matters. inherently, when you're talkingabout value, you have
to take the price per share andyou multiply it times the number of shares. so these stock a and stock b,these are different than the ones i drew down here. so let me draw a little dividingline right there. and let me erase some of this. so if in this example-- letme actually erase more. so in this example, it'simportant to write down the number of shares you have. andyou could look this up on
yahoo finance. and we'll do this in the future with a bunch of companies. we'll just go through themotions of figuring out all of the metrics. just because that's a goodstarting point just to get a sense of what the company'sall about. so let's say that this companyhas ten million shares. and this company right herehas 500,000 shares.
so what you do is you multiplythese numbers to figure out, what is the market value or themarket capitalization of the company? so that's a word. let me write that down. sometimes calledthe market cap. market capitalization. and it's essentially, whatis the market saying the equity is worth?
in this case where you don'thave debt, they're actually saying what is theasset worth? so if i took this, $1 per sharetimes 10 million shares. the market is saying, thiscompany's worth $10 million. or that the equity of thiscompany's worth $10 million. in this case, they'resaying $10 per share times 500,000 shares. they're saying it'sworth $5 million. that's the market capitalizationof the company.
that's what the people aresaying the company is worth. and actually i'm runningout of time from there. so in the next video we'll talka little bit about how do people actually determinewhat something is worth? and that obviously can be aninfinitely deep discussion. but we'll try to get ourfeet wet a little bit. see
