Price and market capitalization | Stocks and bonds | Finance & Capital Markets | Khan Academy

I’ve had enough requests by now
for videos on investing, that I thought I would make
some videos on investing. And the way I’m going to go
about it is, over the next few videos, I’m going to give people
the vocabulary of at least how do you think
about investing? And what are the terms and
the 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 use
those tools later on, and then hopefully we’ll look at some
particular companies. And my goal isn’t to do what
they do on CNBC and tell you, buy, buy, buy, and
sell, sell, sell. Because frankly that’s
not a thoughtful way of going about things. What I want to do is really give
you 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 too
strong about them, because if I’m wrong I don’t want you
to lose your 401(k). So the first thing that I guess
you could say bugs me a little bit, is I go to these
family gatherings, and some uncle or aunt will come
up 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 the
time, but it’s only $1. It’s a cheap stock. As opposed to implicitly there,
there’s the assumption that a $10 stock would
be expensive. And I think this is very obvious
to you, but let me write that down. So price per share. So when someone tells me that
a $1 stock is expensive, they’re implicitly saying, well
that’s just because it’s a low number, as opposed
to, say, a $10 stock. Let’s call this Stock A. And Stock B. And I think this is very obvious
to 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 members
who are doctors and engineers tell me this. So I thought it’s a good
place to start, to clarify any confusion. So my question to you is, is
something that is $1, is that cheap relative to something
that 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 that
a share is just a share. It doesn’t somehow represent
the entire company. It’s a fraction of
the company. It’s just a share. And all companies don’t have
the same amount of shares. For example, if I have one
company– and actually maybe that’s a good point to introduce
a balance sheet– let’s say one company whose
assets, because I want to do this throughout our
discussion. Whose assets are worth,
let’s say, $1 million. That’s its assets. All its buildings and its
employees and its brand. It’s worth $1 million. Let’s say it doesn’t
have any debt. And we’ll introduce debt later,
because that’s another variable that a lot of people
don’t think about when they look at stocks. They just look purely at the
equity value or the market capitalization. And all these terms we’ll
hopefully get very familiar with over the course
of these videos. But let’s say its assets
are worth $1 million. It has no liabilities. So the asset value
is all in equity. So this is all equity. Sometimes called stockholders’
equity. And the equity is really, the
people who own the company. what is their stake? So in this case, they never
borrowed any money to buy these assets. So the owners of the company
own all $1 million, if you believe that this is really
worth $1 million. Now you could have
this scenario. Let me actually draw the same
scenario over again. Let me copy and paste this. soon. So these are two equivalent
companies. Completely equivalent
companies. 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 value
per share? Each share in this case– once
again, 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 held
by the equity holders. So each share would be worth
$1 million divided by 10, which is equal to $100,000. Obviously you never see $100,000
shares out there, or at least not in the great
majority of examples. So this is a bit of an
artificial example. More likely a company might
have a million shares, in which case this would
be a $1 stock. But anyway, this is
a case where they only have 10 shares. It’s $100,000. Now let’s say this company
right here says, well $100,000, that’s
kind of a crazy number for a share price. It’ll keep a lot of people
from buying our shares. So let’s just divide it
into a million shares. So they have times one
million shares. So in this situation, the
company is worth what? Or the shares are worth what? They’re worth $1 million divided
by one million shares, or $1 per share. So going back to the idea where
my family member would come to me at a party, they
would say oh, look how cheap this company is compared
to this company. Even more, let’s say for
whatever reason, because not so many people could afford this
stock, because just to get in the game, you’ve
gotta put up $100,000 to buy a share. Let’s say this stock
trades down, and it’s trading at $50,000. And their assets
are identical. So obviously there’s no two
companies that are identical in this way, but let’s
say that they are. Let’s say in both cases the
assets of this company are worth the exact same thing as
the assets of that company. So here investors are valuing
this company at $1 times a million shares. They’re valuing these assets
at $1 million. In this case, the investor is
saying, OK, I’m willing to pay $50,000 per share. And there’s only 10 shares. So they’re valuing the
assets at $500,000. And this is of course the market
value of the assets. And we’ll talk more about
market versus book value of assets. But the market value or assets
is essentially, what is the market saying the assets
are worth? The book value of the assets, or
what the accountants within the company are saying
the assets are worth. And there’s a whole methodology
to how one would account for that. But this is the market
value of the assets. And I already told you that
these assets are identical. They generate the same
earning stream with the exact same risk. So in this situation, you’re
paying $500,000 for the same asset that over here you’re
paying $1 for. I don’t care what the actual
share price is. This is what you’re
valuing it at. So the person who says that $1
here is cheap, relative to $50,000 here. And they might even say, oh well
they’re the same company. And I get it here for $1 a
share, and I get it there for $50,000 a share, this
is a cheap company. But that’s completely
180 degrees in the wrong direction wrong. Because you’re actually paying
more for this company. You’re paying $1 for one
millionth of this company, while you’re paying $50,000
dollars for one tenth of this company. So this one is actually
the better deal. So in general, when you’re
trying to figure out relative price of a company– and we’re
going to talk a lot more about ratios and how do you know if
something is inherently cheap, you relative to its earnings or
what 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 a
meaningless number. It matters to some degree
for trading purposes. Where a lot of institutional
funds won’t look at a stock that’s below $5. A lot of stocks that go
into the penny stocks. There’s a lot of frictions in
investing 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 have
a penny stock. Let’s say you have a stock
that’s at $0.05, it can only move by a penny in
one direction. And before it was actually
an eighth. So if you move only by a penny
you can only go to $0.06 or you could go to $0.04. And so in either direction
you’re looking at a 20% move, while here you’re looking at a
1/1000th move or a 0.1% move. So that’s one reason why
price might matter a little bit here. There’s huge frictions if you
were to buy and sell, there’s 20% every time. And we’ll talk about things
like bid-ask spreads and liquidity and things like
that in the future. But that’s where the price
really starts to matter. And obviously if you have a
really huge price, like $100,000, that makes it
difficult for people to buy even one share. But that’s the only place
where price matters. Inherently, when you’re talking
about value, you have to take the price per share and
you 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 dividing
line right there. And let me erase some of this. So if in this example– let
me actually erase more. So in this example, it’s
important to write down the number of shares you have. And
you 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 the
motions of figuring out all of the metrics. Just because that’s a good
starting point just to get a sense of what the company’s
all about. So let’s say that this company
has ten million shares. And this company right here
has 500,000 shares. So what you do is you multiply
these numbers to figure out, what is the market value or the
market capitalization of the company? So that’s a word. Let me write that down. Sometimes called
the market cap. Market capitalization. And it’s essentially, what
is the market saying the equity is worth? In this case where you don’t
have debt, they’re actually saying what is the
asset worth? So if I took this, $1 per share
times 10 million shares. The market is saying, this
company’s worth $10 million. Or that the equity of this
company’s worth $10 million. In this case, they’re
saying $10 per share times 500,000 shares. They’re saying it’s
worth $5 million. That’s the market capitalization
of the company. That’s what the people are
saying the company is worth. And actually I’m running
out of time from there. So in the next video we’ll talk
a little bit about how do people actually determine
what something is worth? And that obviously can be an
infinitely deep discussion. But we’ll try to get our
feet wet a little bit. See

33 Replies to “Price and market capitalization | Stocks and bonds | Finance & Capital Markets | Khan Academy”

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