Say there are a million shares of BigCo.
On day 1, 250,000 shares are sold for $1.
On day 2, 250,000 shares are sold for $1.25
On day 3, 250,000 shares are sold for $1.50
On day 4, 249,000 shares are sold for $1.75
On day 5, 1,000 shares are sold for $2.00
At the end of day 5, the share price is $2.00 and BigCo’s value is 2 Million dollars. But, really, only 1.377 Million dollars has been invested in the stock. It’s the same thing with the Stock Market as a whole - the closing price determines the value of every share, which doesn’t make much sense to me. People even acknowledge this, when they talk about the net worth of Gate or Buffet - it’s well known that if they started selling, they wouldn’t get anywhere near their book value for the stock they own.
So, why isn’t the valuation equal to the sum of all trades?
BigCo is worth two dollars a share right now because anyone can sell their shares for two dollars each, because that’s what somebody is willing to pay. It is supply and demand, nothing more complicated than that.
If you’re interested in the reason why people are willing to pay a certain price, then there’s a few hundred interesting books on the topic.
It’s not magic. Shares of stock are fungible - the guy who bought today at $2 and the guy who bought 5 days ago for half that, are both capable of selling a share today at the current price.
It’s a paper profit, of course, but at any point you can sell the shares. That’s part of the point of owning stock: you buy the shares at $1 and try to sell it at a higher value. The value is determined by the demand for the shares.
It’s like anything else. If demand for an item goes up, and supply remains steady, then the price goes up. People are willing to pay more. The same thing works for any item: if you buy a house, the value goes up or down.
This statement isn’t so much wrong as meaningless. No money is ever invested in a stock, except in the same sense that you can invest $37.50 in a savings bond and eventually turn it in for $50.00. The worth of a share of stock is the net present value of that percentage share of what people believe the company’s worth will become.
The total value of all stocks, the company’s market cap, is not an official number. It’s thrown around but mostly as an estimate of what investors think the future will be like. That future changes every minute, which is why the stock price changes every minute.
That’s also why nobody cares what a stock has gone for in the past. That’s an obsolete view of the future. It’s been superseded.
What’s the “real” number? There is none. Either the company goes on forever or it’s bought for a set price that establishes a value as of that moment or it goes bankrupt, which sets the value at zero. Anything else is a prediction and has the validity of all predictions.
Yes, I realize all of that.
That’s not my point - which is: if there are a billion shares of stock, and I buy one share for $1 more than the last closing price, why does that increase the value of the company by a billion dollars? I understand that it easier to do it that way, but it’s certainly not more accurate - look how much “value” has evaporated from the stock market recently.
Because it’s a book value only. And “1.377 million dollars” weren’t invested in BigCo - whatever was paid for shares at BigCo’s Initial Public Offering (and re-investments, and placements) were actually invested. The “market capitalisation” is just that - the current market price for all of the company’s shares, assuming you could find a buyer.
The price paid for other shares are relatively meaningless if you want to buy or sell today. The terminology is used as shorthand to consider current (i.e. not yesterday’s) market price.
The company’s value has not been increased by a penny. The company’s market cap has increased, but as I said nobody knowledgeable pretends that the market cap is a reflection of the real value of the company. It’s an approximation, a rule of thumb, a quick way of thinking, nothing more.
It most certainly is more accurate (especially if you’re comparing that to the amount of money previously paid for the stock). A good approximation has real world accuracy and usefulness. For one thing, the market cap gives a floor to the number that any would be buyer of the company would have to pay. For another, the value of the stocks you own can be used as collateral for other loans or investments. Collateral can vary in value - put up the value of your house as collateral for your mortgage and you can be in trouble if that value goes down and you want to sell. Similarly, you can be in trouble if you put up stocks as collateral and their value goes down; that’s what brings on margin calls, for example.
That’s why the value that has disappeared from the stock market has been such an issue recently. People took that value and invested it in other products to gain more wealth. When that base went away so did all the other value, compounding the problem.
You can’t argue that it’s not “real.” To be “real” in your terms something would have to have intrinsic value. Nothing does. Everything has only the value of what someone is willing to pay for it. The only way we have to determine that value on a moment to moment basis, for this example, is the current price of a stock. That’s why it is so absolutely critical to everyone. It’s the only reality that exists.
I get your point and its an interesting way to think of market capitalization. In essence the last closing price is a marginal price for the next X number of shares. After a certain fairly large purchase you have to pay more for each subsequent share. Likewise if the owner of large numbers of shares sell, the current closing price is for the next X number of shares. If he keeps selling the price progressively drops.
I don’t think the method you propose is better though. The price of a stock is highly sensitive to the time it is quoted. So if those trades you quoted are separated by several days then the older trades are worthless from an informationally standpoint. I would guess we use the last closing price because it is the best method we have. All others are either too complex or less perfect.
Just a question for those who know more than me - is this how it works? If the price of a share is $100 and one person buys one share for $101, surely that doesn’t make the share price $101? I thought the share price was determined by an average number of purchases over a period of time - so when a significant number of people start buying the shares for $101, only then does the share price change to reflect that price.
It makes the share price $101 for the person who buys it at $101.
The price quoted on the stock ticker reflects the last recorded sale of that stock. The share price at any given moment is what you would pay for a stock at that moment.
Note that the amount you pay and the amount the seller gets is not the same; the trader gets a little bit of each transaction. If you offer $101 and the seller is ready to accept $100.80, then the trade goes through, with the specialist (n the NYSE) or market maker (in NASDAQ) getting the difference.
And the purpose of the specialist/market maker is to make sure shares are available to buy and that someone is willing to buy shares. If you want to sell your stock, you are guaranteed someone will buy it (though not at any particular price). If the specialist/market maker can’t find a buyer or seller for you, they will buy or sell from their own account.
It does make the share price $101, and don’t call me Shirley.
The stock price is the last trade price. People are interested in that because they’re interested in what they can sell their stock for, not the average price of all trades of that stock. What the stock sold for last week isn’t interesting to me, I need to buy or sell the stock today. The last trade is a good indication (not perfect) of what I can get for my stock, especially with large volumes changing hands.
The quoted share price makes sense if you want to buy or sell a relatively limited number of shares in the company. So, if the last trade was $2, and you want to buy or sell 1,000 shares in a company with many millions of shares in public hands, then you will spend or receive close to $2,000.
When it doesn’t make so much sense is when you want to buy or sell a large fraction of the company’s share-holdings, especially if it’s a large number relative to the number of shares bought and sold on a daily or weekly basis. If you are selling a large parcel of shares, that’s going to push the value down; if you are buying a large parcel of shares, that will push the value up.
So the OP’s question does make some kind of sense. Suppose you are Mr Big, the founder of BigCo, and you personally own half of those million shares, which last traded at $2. Now your daughter (Ms Big) comes to you and says, “Daddy, I want a dream wedding, next week, and it will cost just $1 million, so sell all your shares, and we can afford it.” Well, if you tried to sell all those 500,000 shares in a week, it would push the price down, especially if it got rumoured that the company’s founder was getting out of the business, and at the end of the week the price would have dropped, and your stockbroker would tell you that you had received a lot less than $1 million for your parcel of shares. So, in that scenario, the company is worth a lot less than $2 million.
“Price is what you pay. Value is what you get.” – Warren Buffett
What any particular entity is willing to pay for any particular share of stock has no bearing on the value of the company itself. The company at any given moment is worth what it is worth. There are lots of ways to go about estimating the value of a company based upon various characteristics of that company. But a company is a real entity. It has assets and liabilities, and it has the ability to utilize these balance sheet items to generate revenues and profits (hopefully). And shareholders are partial owners of these companies.
The value of a company is tied to its future earnings potential. The values of companies have indeed gone down recently, not because of some gyration in stock market pricing, but because economic conditions have reduced the profit-generating power of these companies. Of course, now buyers and sellers have to re-price the stock shares of these companies to reflect the new reality, and these re-pricing efforts are only best guesses since the future is always uncertain.
From an investor’s standpoint, the lost value due to reduced prices is in some sense fiction. You still have precisely the same stake in a company that you did yesterday; you have the same shares regardless of how the markets are pricing the stock at any point in time. You lost value not because the share price went down, but because the company’s ability to generate profits has been negatively impacted. However, many investors are not interested in being partial owners in a company, sharing in the fortunes and misfortunes of the company. They are only interested in buying a piece of a company so that they can sell that piece at a higher price later. In this sense, stock price is the only metric of personal value. So they tend to equate stock price with stock value and act accordingly (Do I have enough to retire? How’s the kid’s college fund doing?).
So if a stock is listed as $100, and a dozen buyers purchase 1000 shares each for $101, and then ten minutes later I buy one share for $200, the share price becomes $200? Or have I misunderstood the processes involved completely?
Yes. If you decide to pay $200 for the stock, even though everyone else is buying it for $100, the stock price will be reported as $200 for that sale.
Of course, no one is dumb enough to do this; people buy for the lowest price possible and sell for the highest. Also, it’s rare to buy or sell a single share; they’re usually sold in lots of 100 (if fewer, multiple “odd lots” are combined into one purchase). If, however, you buy 100 shares, you can pay whatever you wish that a buyer will accept.
If you watch a stock ticker (say, the crawl on Bloomberg), it shows every sale of stock on the exchange – symbol, price and (sometimes) number of shares.* Those who follow the market watch these to see how their stocks are doing; each individual transaction is reported. So the ticker would indicate someone paid twice what was normal for the stock. People would try to determine if this was a fool throwing his money away or if it’s real, partly by watching for later sales. But if somehow you managed to get your sale in as the last sale of the day, then the stock would close at that price.
Actually, if the ask price for the stock is $101 and you try to buy one share for $200 on the stock exchange, you will only pay $101.
If the bid/ask is $100/$101, then the true price for the next share of stock is $100 if you’re selling and $101 if you’re buying. The most recent traded price is irrelevant.
