17. Investing Basics Part 1 - Stocks

Transcript:

Hello, and welcome back to the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. 

Today, we're looking at part one of my introduction to investing series. We're going to be talking about stocks today. What are stocks? How can you actually make money with stocks? What affects their prices and why you might want to consider owning them yourself. 

Before we get going today, I just want to reiterate that your specific circumstance will determine what investments are appropriate for you. This podcast is intended to be general information only, and it isn't personalized advice or recommendation to buy shares of any of the companies I mention. 

I'll mention a couple of companies that you've probably heard of before and that's just so that you can relate to it a little bit easier, but it is not a specific recommendation to purchase shares in that company. Okay, now that we have that out of the way, let's get going. 

So, what are stocks? You can think of stocks as simply corporations that can be owned in small pieces. These small pieces are called shares and they can be owned by the public. So, when you own shares in that company, you essentially become a part owner of that company. When you own something, you can say you have equity in it. 

I'm a huge fan of the show Shark Tank. Here in Canada, we have Dragon's Den, which is something similar, but you'll often see the people coming on the show asking for say 10% equity in exchange for $50,000, the equity that they mentioned there is actually the ownership in that company. And the same is true with stocks.  When you own shares, you have equity in that company. So sometimes shares, as a category are referred to as equities as well.  

So again, equity just refers to ownership and so when we talk about stocks or shares or equities, we're just referring to the same thing and that's just an ownership stake in a company. 

When you own a business, you share in the profits, but you also share in the losses. The same is true with stocks. The prices will change frequently for better or for worse and your ownership stake will fluctuate. Accordingly, companies will sell shares to raise money for operations through something called an initial public offering or IPO. You might see that acronym in news headlines once in a while.  

So, an owner of a company would then say, okay, I'd like to raise some money so I'm going to sell a stake in my business for a set amount of money. And those shares will be made public for people to purchase. Then once the initial sale happens, stocks are bought and sold between investors, not the company itself. 

So, if a price goes up, the company doesn't necessarily benefit from that. The owners of the shares do. Oftentimes executives and founders and things like that will retain a certain portion of the equity for themselves. But the company isn't specifically raising that money when the stocks are traded between investors, these shares are bought and sold through something called a stock market or a stock exchange. 

This isn't a physical market anymore. You might've seen movies or videos of guys yelling and screaming at the New York stock exchange and things like that. Those trading floors still exist to an extent, but most stock trading happens online these days. So you can access the stock market through a broker or even online brokerages where you can buy and sell stocks from your computer or smartphone. 

There are many different markets per se, around the world. So it's a bit of a misnomer to refer to “the market” in general, because Canadian stocks won't always behave the same as U.S. stocks or German or Japanese stocks, but functionally, each market provides the same service, but just access to different companies depending on where they're listed. 

People talk about the market in general. They're usually referencing something called an index that takes a group of companies and tracks the average performance of that group. Rarely does one specific index give the full picture of what's going on, but it's often a decent way to get the gist. 

So how do you make money with stocks? Well, the first way is through something called dividends. When a company has profits, they can choose to pay a dividend to shareholders. Dividend is essentially just sharing in the profits of the company with the owners. Dividends are typically a set dollar amount per share.  So for example, if a company is paying a 50 cent dividend per share, and you own a hundred shares, you would receive a payment of $50. This isn't always the case, but dividends are often paid by well-established companies that have good cash flows but aren't necessarily an innovative or what we would call growth industries. 

There are exceptions to that, of course, but things like banks, utility companies, real estate firms, etc, they're all typical dividend payers. Not every company pays dividends however, they will often reinvest profits back into the business and they do that by expanding into new markets, buying equipment, or hiring people. 

The other way to make money with stocks is when your shares increase in value and we might refer to that as capital appreciation. Over time, if a company shows to be highly profitable or is providing innovative service or some other factor that drives buying interest in the company, the price of a stock might increase. 

This can happen for many reasons, but if you bought a share for say a hundred dollars, and now it's worth $120, you'd have a gain of $20 per share on paper. If you don't sell your shares, you haven't really made any money. But just the shares you own have increased in value.   

Kind of like your house, if it increases in value, you're not suddenly rich.  If you sell your house, then you have money that you can use. However, the opposite is also true. If prices drop to $80 in this example, that means that you'd have a loss of $20 per share. Again, you'd only officially lose money once you give up your shares by selling. 

So, what are some factors that affect the price of a stock? The first one is the number of shares that exist. Think of a pizza. There's a place here in town, it says they described themselves as being a New York style pizza and they have huge pieces. So a regular pizzas cut into four slices per pizza.  Domino's or Pizza Hut, for example, might cut that same pizza into eight slices. But for example, both places might charge $20 for that same pizza. So at the New York style place, each piece would cost $5, but at Domino's each piece would cost $2.50. 

This is kind of like stocks.  A company with a high share price doesn't mean it's more valuable. For example, as of this recording, a share of Google, which is actually known as Alphabet, that's the parent company of Google.  But anyways, a share of Alphabet is worth about $2,000 more than a share of Apple. 

But when you multiply that share price times the number of shares that exist, you'll see that Apple is worth nearly $700 billion more than Alphabet. 

That equation I mentioned of share price times the number of shares, it gives you what a company is worth at any given moment in time in the public market.  We call that market capitalization or market cap. Sometimes you'll see a reference to things like small cap or large cap, or even mega cap regarding companies like Apple. 

But this essentially just describes whether a company is small, large, or mega huge, for lack of a more technical term. 

In some cases, companies will do something called a split.  In cases like this, for example, the pizza that is cut into four pieces gets cut into eight. Now, if you own two pieces before you'd now own four pieces, but the pieces would be half the size. You don't have more pizza, but you have more pieces. 

And the same is with stocks. Sometimes they'll cut the price in half and give you twice as many shares. This doesn't mean you have any more equity in the company. You just have smaller pieces worth less money, but more of them. 

So again, back to the IPO thing. So when a company originally goes public and they sell their shares for the first time, the initial price has been set after that, the day to day or minute to minute or second to second changes in the price of a stock will fluctuate simply based on supply and demand. 

That's it. If there are more people that want to buy the stock price will go up. If there are more people who want to sell the price will go down. So the better question is probably what makes people want to buy or sell. 

I wish I could say it was based on fundamental analysis of a company's assets, revenue, dividend payouts, corporate culture, et cetera, et cetera, but more often than not, people will buy and sell stocks based on greed and fear. February and March of 2020, it was a perfect example of this. When COVID first began to spread in North America, there's a lot of fear about what the world would look like. 

And so investors started selling everything, hoping to prevent losses, but when more people want to sell, it'll drive the price down. So, selling into a declining market can be something like a self-fulfilling prophecy by trying to prevent losses by selling everything the market will inevitably decrease in value. 

Now you and I don't have enough money to move the needle on the whole market, but when enough people do this, it can have a significant impact in a short amount of time.  Using the same period, as an example, around March 23rd, the stock market turned around very quickly and started to increase in value. 

But this growth wasn't being seen in every company, companies that thrive in the stay-at-home economy were performing really well because everyone was seeing how profitable they might be in the short term. You can guess which companies; these were just based on your own behavior. If you're doing things like more online shopping and video conferencing, companies providing these services were among the obvious winners in the rebounding market. 

So just like the fear of losing everything on the way down, the fear of missing out on the way up drove these stock prices way higher than their sales might warrant. People wanted to own the winners. Fear drives prices down too far, and greed drives prices up too high. This oscillating behavior isn't unique to COVID times, investors generally overreact in both directions, which makes stock investing a bit of a roller coaster. 

So, knowing that why should you own stocks? I can understand how people might think its kind of like gambling. But even though stocks can bounce around in value, over the long-term and when I talk about long-term, I generally mean in the ballpark of 10 plus years, the stock market has been a pretty reliable place to make money. But this is the classic risk and reward trade off.  Buying stocks isn't only reward, there will always be periods of time where things look a little ugly. But if your timeline is long enough, owning stocks might be a good way to have your money work for you. I'm not here to convince you that buying stocks is appropriate for everyone, but historically it has been one of the best places to earn investment returns if you can handle the volatility or the frequently changing price. 

The constantly changing prices is one of the more unique features of the stock market. Think of your house again. What would you do if someone knocked on your door every hour and told you how your house is changing in value, you probably start to question owning a house.  The same is true for stocks.  If your timeline and goals and financial knowledge leads you to investing in stocks in the first place, constantly checking on the changing prices might drive you insane. The more you look, the more you'll be convinced to make decisions that might not work in your favor long-term. 

Again, keep in mind its fear and greed that drives most of the short-term movements of the market. 

So let me summarize some of these questions here again. So what are stocks? They're ownership pieces of companies that you can own yourself, when you own shares of a company, you share it in the good and the bad along the way.  

How do you make money with stocks? The two main ways are either by dividends, which is a payment of profits or by the value of your shares increasing 

What affects the price of a stock? Well, many factors of course, but mainly the number of shares that exist and the current level of demand for those shares. If lots of people want to buy, the price will go up. If more people want to sell, the prices will go down. This behavior is often driven by fear and greed, but over time it should be more reflective of the overall profitability of that company. 

Why should you own stocks? Even though the prices are volatile, investing in stocks has historically been a reliable way to make money in the long-term. If you have financial goals that are more than 10 years down the road, stocks might be a helpful tool to help you reach those goals. 

Now I mentioned some companies that might have really, really expensive stocks and you'd say, okay, well, I'm just getting started. I don't have thousands and thousands of dollars or significant knowledge about which companies are good and which ones I should avoid. And so in a subsequent episode, I'll talk about some of the easiest ways to buy stocks and other investment tools that'll help you to get access to this type of investment. 

Thanks for joining me today on the Canadian Money Roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on Apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes. 

This podcast is intended to be educational in nature, and you should always consult your financial team, Tax and legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes only. Evan Neufeld is a Qualified Associate Financial Planner and Registered Investment Fund advisor.  Mutual funds are provided through Sterling Mutuals Inc.