Nowadays, it is rare to turn on the news and not hear about some type of investing. Whether talking about investing in cryptocurrency or a company that has been showing limitless potential in the past recent months, this term has been aimlessly thrown around recently. However, what even is investing in stocks?, and why is it important to know this?
When investing in a company it is essential to take a look at the company’s assets and liabilities. This cautionary step will allow the investor to make sure their money is being put into a reliable company, that will most likely raise the value of their investment. The assets that a company possesses is simply anything that they own which has value, for example warehouses, inventory, etc. If these assets were to add up to $200 million for a theoretical company, then this amount has to be subtracted by the liabilities that company has to ultimately calculate the owner’s equity.
Liabilities can be as simple as the amount of debt a company has, but also can be more complicated like the amount of bonds the company issued. In this case, for the theoretical company we say that the liabilities of this company add up to $90 million. As I mentioned before by subtracting the assets from the liabilities we are able to calculate the owner’s equity($110 million in this case). This owner’s equity is where all the investing happens, essentially when buying a certain amount of stocks you are becoming a part owner of the “owners equity” portion of the company. Now to take it a step further and calculate the price per share for this theoretical company, we have to divide the owners equity by the amount of shares. Since there is no set amount of shares for this theoretical company, we can make up a number and say that this company has five million shares. Now 110 million divided by 5 million equals 22, which means that the price for a single share of this theoretical company would be $22 per share. What must also be taken into account is the market cap of this theoretical company. If the market cap of this company was valued at $98 million, then that means that the “last trade” value of this company would be multiplied by the number of shares(5 million) to equal $98 million. Considering if the market cap was lower than the owners equity, then this means that the market does not truly believe that the assets the company possesses are worth $200 million. So instead of $22 per share, the “last trade’ value that is being multiplied by the amount of shares to equal $98 million has to be less than $22.
In the end, it is always suggested that a potential investor not only takes a look at the company’s financial statements, but also the market cap because as we saw in this theoretical situation the market did not value the company as highly as the company valued themselves. These minor checks could potentially be the difference in losing thousands of dollars or making thousands of dollars which is why they should not be skipped.
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