Author Topic: A few misunderstandings about investing  (Read 4653 times)

Vilx-

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A few misunderstandings about investing
« on: May 09, 2013, 04:02:13 AM »
I've never done any buying of stocks, but the process has always mystified me. I just... can't make all the pieces fit on how it works. What I have managed to understand is that when you buy a stock, it means you bought a little piece of a some company. You now own a bit of it (together with other people). But that then raises more questions than in answers:
  • Who keeps track of who owns what? Modern buying & selling is totally electronic. Big players in the stock market buy and sell huge volumes of stocks of a myriad of companies every day. There just cannot be any physical proof (read - signed papers) of this stuff, it has to be electronic. So who does it? Banks? The mystical "stock market"? The government?
  • Together with point 1 goes another problem - all the companies in a country are normally registered with the government. I don't know what the relevant institution is called in USA, but I'm sure there is one, and in every other country too. This same institution also tracks who is the owner of each company - it's important to know this if things ever get to court (you know, so that random people cannot pretend to own a company they do not). Changing owners therefore tends to be a lengthy legal process with fees involved etc. So, if buying a company's stocks makes you an owner, how can it be done so quickly and painlessly?
  • An owner is the absolute power in a company. He can hire and fire anybody, do ANYTHING. He's the one with the "rights of signature" (or whatever it is called in English - he may sign papers in the name of the company). That is what makes him an owner, and others - non-owners. But, naturally, this cannot work if a company is owned by thousands of stockholders. So... are they owners or not? Or are they... slightly-less-than-owners? Do they get to have any say in what the company does or not?
  • Who does all the buying and selling? When people talk about the stock market, it seems that it's always possible to buy/sell anything you want, it's just the price that varies from time to time. But who then is on the "other end" of the transaction? Surely, if it was just other people, it wouldn't be possible to always find a buyer/seller for the price that is listed on the "stock market" website. You'd have to have something like craigslist, where you put an ad and then wait for someone to come to buy/sell from you, often for days or weeks. So does the mystical "stock market" itself buy it? That sounds even weirder.
  • Who determines the price? I would sort of expect that there is a free market that determines the price (like for everything else in our lives), but there are two counter-examples:
    • The price seems to be always determined by "the stock market" and listed in their electronic system (webpage or something). It fluctuates by the minute and people all buy/sell at THAT listed price - not what they agree upon in some negotiations or something. So how is THAT price determined and who does it?
    • When a new company comes out and the initial entrepreneur wants financing for his venture, he starts selling the stocks for the price HE put there himself. Which again seems weird together with points 3 and 4. If in stock market you can sell ANYTIME, then who will always be willing to buy at the price you've listed? And - if he now sells these stocks, does that mean he's not the owner of his own company anymore? Is he now an employee of the shareholders and can be fired anytime or something? It's HIS company after all! Can he issue more stocks later at the price he likes again? Who will buy those?
  • It's always said that buying stocks (aka "investing") helps the owners because you sort of lend them your money to do their business. Therefore it's supposed to be a good thing to do. But after the stock is in the market, you don't buy it from them anymore! You buy it from someone else, and your money goes to someone else. The owners who originally issued these stocks don't see any more money from it, right? So... does "investing" in the stock market help the original owners to run their business or not? Is that just a myth?

gooki

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Re: A few misunderstandings about investing
« Reply #1 on: May 09, 2013, 04:27:01 AM »
I am happy to be corrected, but my understanding is...

1. Both the stock exchange the company is listed with, and the company itself keeps track of who owns shares.

2. Electronic stock exchanges make this possible. The biggest delay is often the confirmation of the transfer of funds (done by the brokers not the stock exchange).

3. Share holders vote in company directors, and these directors run the company on your behalf. There are even non voting shares where you have no control.

4. As a seller, you either put in an offer to sell at market price, or at a set price of your choosing (time limited). As a buyer you either choose to buy at the market price or at offer to buy at a set price (time limited). If there is a match the transaction takes place, and the stock price is updated to the latest transaction price.

5. The latest transaction determines the price. The transaction occurs through an offer/acceptance process.

6. Generally the owner of the business will retain some stock to sell at a later date, so they would see some benefit when they eventually sell. They may even receive a bonus based on stock price increases. But generally no, once they have sold their ownership, they receive no further financial benefit from stock transactions (and rightfully so).
« Last Edit: May 09, 2013, 04:29:11 AM by gooki »

Vilx-

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Re: A few misunderstandings about investing
« Reply #2 on: May 09, 2013, 06:39:05 AM »
OK, that sort of makes sense. :)

One more question - what power do the stockholders have over the director they have elected? If the director said - "Haha! Sayonara, suckers! This is now MY company and I'll do as I please!" - what can they do? I mean, normally, if there was one owner, he could tell the accounting not to pay the offending worker anything and tell the security folks to revoke his keycard. But in this case, everyone else answers to the director, and the stockholders do not have any direct power... How is this resolved?

matchewed

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Re: A few misunderstandings about investing
« Reply #3 on: May 09, 2013, 07:39:58 AM »
There are usually a number of directors not just one. These people don't run the business but they do drive the business. A CEO is usually chosen by the directors. That is the guy who runs the business.

The directors (generally) don't run rampant because they are checked and balanced by a) themselves and b) the investors.

The CEO doesn't run rampant because they are checked by the directors.

daverobev

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Re: A few misunderstandings about investing
« Reply #4 on: May 09, 2013, 09:10:17 AM »
The shareholders can also sack the board, I believe. Votes of no-confidence do happen.

If you are an owner, you will always get the right to vote (as mentioned, assuming you have voting/ordinary shares).

If you own through a brokerage, the brokerage deals with making sure voting materials are distributed to the holder. The brokerage holds those shares in trust on your behalf (and in your agreement with the brokerage, they can make money by lending your shares for short sale and so on).

If you go and look at the price of a smaller company, you will see the price zig-zag - when there is not enough 'liquidity', ie not enough shares are bought and sold to make prices change smoothly. You might put a bid in for 2000 shares at $1, but only 100 are for sale at $0.98, then the next sale is 5000 as $1.10 - you would only end up buying 100 shares. But with any large company, there are hundreds of millions of shares, often interlisted on multiple stock exchanges, and god knows how many 'limit' orders (I'll sell 500 if the price gets to $1.10! And another 500 if it gets to $1.20!).

I mostly buy and hold, but I can easily go in and go, ok, I can see the price of share X is dropping a bit... hmm, I'll put an order in to fire if the price hits Y. It's like a tug of war between the bulls (to the moon!) and bears (end of the world!) (well.. kinda :))

If you have, say, 100 shares of the Bank of America you have only a tiny amount of 'clout' with the company; but you can go to the shareholder meetings, you can ask questions of the board, and you can vote - just like in an election. Nobody can take those shares away from you, though the company can issue MORE shares which leads to 'dilution' of the value (unless they are raising money to buy something valuable, but even so your 100 shares are a smaller percentage of the whole).

The board, the directors, the managers, they are ALL your employees, and it is their job to work for the benefit of the shareholders. That is why you pay them!

Joet

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Re: A few misunderstandings about investing
« Reply #5 on: May 09, 2013, 10:04:33 AM »
on a sidenote I patently REFUSE to hold single issue company stock [outside of my employer, no choice, I sell as soon as I am able] :)

Now collectively, in a broad index---sure. Just wanted to mention that.

Also, what happened to all the indexers with the "apple" tilts? Where have they gone lol? Remember last year or 3 when apple basically fueled all the index growth so people said "hmmm, time to juice those returns?", yet another argument against single issue tilts---regardless of how much sense it makes or because everybody is doing it or because it doubled effective returns last year etc :)


Apple tilters.... google it if you want a good laugh.

brewer12345

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Re: A few misunderstandings about investing
« Reply #6 on: May 09, 2013, 10:13:27 AM »
I've never done any buying of stocks, but the process has always mystified me. I just... can't make all the pieces fit on how it works. What I have managed to understand is that when you buy a stock, it means you bought a little piece of a some company. You now own a bit of it (together with other people). But that then raises more questions than in answers:
  • Who keeps track of who owns what? Modern buying & selling is totally electronic. Big players in the stock market buy and sell huge volumes of stocks of a myriad of companies every day. There just cannot be any physical proof (read - signed papers) of this stuff, it has to be electronic. So who does it? Banks? The mystical "stock market"? The government?
  • Together with point 1 goes another problem - all the companies in a country are normally registered with the government. I don't know what the relevant institution is called in USA, but I'm sure there is one, and in every other country too. This same institution also tracks who is the owner of each company - it's important to know this if things ever get to court (you know, so that random people cannot pretend to own a company they do not). Changing owners therefore tends to be a lengthy legal process with fees involved etc. So, if buying a company's stocks makes you an owner, how can it be done so quickly and painlessly?
  • An owner is the absolute power in a company. He can hire and fire anybody, do ANYTHING. He's the one with the "rights of signature" (or whatever it is called in English - he may sign papers in the name of the company). That is what makes him an owner, and others - non-owners. But, naturally, this cannot work if a company is owned by thousands of stockholders. So... are they owners or not? Or are they... slightly-less-than-owners? Do they get to have any say in what the company does or not?
  • Who does all the buying and selling? When people talk about the stock market, it seems that it's always possible to buy/sell anything you want, it's just the price that varies from time to time. But who then is on the "other end" of the transaction? Surely, if it was just other people, it wouldn't be possible to always find a buyer/seller for the price that is listed on the "stock market" website. You'd have to have something like craigslist, where you put an ad and then wait for someone to come to buy/sell from you, often for days or weeks. So does the mystical "stock market" itself buy it? That sounds even weirder.
  • Who determines the price? I would sort of expect that there is a free market that determines the price (like for everything else in our lives), but there are two counter-examples:
    • The price seems to be always determined by "the stock market" and listed in their electronic system (webpage or something). It fluctuates by the minute and people all buy/sell at THAT listed price - not what they agree upon in some negotiations or something. So how is THAT price determined and who does it?
    • When a new company comes out and the initial entrepreneur wants financing for his venture, he starts selling the stocks for the price HE put there himself. Which again seems weird together with points 3 and 4. If in stock market you can sell ANYTIME, then who will always be willing to buy at the price you've listed? And - if he now sells these stocks, does that mean he's not the owner of his own company anymore? Is he now an employee of the shareholders and can be fired anytime or something? It's HIS company after all! Can he issue more stocks later at the price he likes again? Who will buy those?
  • It's always said that buying stocks (aka "investing") helps the owners because you sort of lend them your money to do their business. Therefore it's supposed to be a good thing to do. But after the stock is in the market, you don't buy it from them anymore! You buy it from someone else, and your money goes to someone else. The owners who originally issued these stocks don't see any more money from it, right? So... does "investing" in the stock market help the original owners to run their business or not? Is that just a myth?

1. Google "DTC"

2. Google "settlement process"

3. The shareholders are the owners and they appoint the board of directors to oversee the affairs of the company on the shareholders' behalf.  They hire the managers (CEO, etc.) of the company to run the business.  Ownership and management are thus separated in large corporations.

4. Individuals, institutional investors, sometimes market makers, and computerized trading are how share sales are done.  Every share traded is the same as the last one, and all trading in a particular security is done one one platform, so you have a concentrated market which helps liquidity.  The bigger and higher volume a security is, the more liquid it is and the less any individual buyer or seller of the shares can move/set the price.  In contrast, very small public companies often see low liquidity and it can be hard to buy even a retail amount of shares without moving the price a lot.

5. Supply and demand for the shares at any given moment as shown by market participants' willingness to buy or sell at a particular price.  Ideally, market participants take all available information into account when figuring out what price they will buy or sell for, but often human emotion and other factors are at work as well.

6. After the initial injection of capital into an operating business through the sale of shares to the initial investors, the market provides liquidity to anyone who wishes to buy, sell or own those shares.  The presence of this market helps determine the cost of capital for the business and based on the opportunities the business has for investment and the capital it has on hand to invest with, the public company may elect to sell more shares to raise more money, repurchase shares because it has poor investment opportunities compared to the cost of capital, or just make do with what they have on hand.

If you really want to learn about this stuff in a reasonably approachable manner, pick up a used copy of "Fundamentals of Corporate Finance" by Brealey and Myers.

Undecided

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Re: A few misunderstandings about investing
« Reply #7 on: May 09, 2013, 10:58:50 AM »

1. Google "DTC"

2. Google "settlement process"


But then Google "record owner vs. beneficial owner," "street name" and "transfer agent" too.

Freeyourchains

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Re: A few misunderstandings about investing
« Reply #8 on: May 09, 2013, 11:16:13 AM »
Now if you founded the business from absolutely nothing, and continue to own 70% of all shares that started out as worthless as the day you registered your imaginary company, and even if you elect a board of directors and someone else to manage the company as CEO, but not a founder.

Then they usually make the day to day operations flow, while you passively enjoy the dividends (usually increasing), and or any occasional capital gains from sells or invested buy backs at low prices then sells at high prices.

Of course you sit with the board of directors or get the decisions, because it's still your signature required to sign off of on all big changes because you own 70% of the entire company and have final say, but usually you just put your trusted CEO in charge while you collect passive incomes, unless something is happening that you don't like.




tylerherman

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Re: A few misunderstandings about investing
« Reply #9 on: May 09, 2013, 12:47:08 PM »
I would file these questions under - "Don't need to know"

I don't know how my microwave works and I don't need to know. I bet its magic!

With the advent of the internet way too much information became available to everyone and the first thing to learn is how to ignore 99% of it. Just focus on the 1% you need to know to keep your life moving forward.

The stock market has functioned successfully for over a 100 years so you can assume safely that all of these concerns have been addressed already. So don't worry about how it works and focus on picking the right investments.

daverobev

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Re: A few misunderstandings about investing
« Reply #10 on: May 09, 2013, 01:45:53 PM »
I would file these questions under - "Don't need to know"

I don't know how my microwave works and I don't need to know. I bet its magic!

With the advent of the internet way too much information became available to everyone and the first thing to learn is how to ignore 99% of it. Just focus on the 1% you need to know to keep your life moving forward.

The stock market has functioned successfully for over a 100 years so you can assume safely that all of these concerns have been addressed already. So don't worry about how it works and focus on picking the right investments.

I disagree. You need to find out what it is that you need to know. You need to read the instruction manual. Admitted you don't need to know *exactly*, as there are various different ways of doing things on different exchanges, and so on.

Your microwave example - you need to know not to put metal inside! That isn't "obvious". As a shareholder you need to know about ex-dividend dates, classes of shares, etc, etc. You need to have a rough idea of your rights and responsibilities as a shareholder. MANY people buy "too much car" because the people selling them the car profit from it. MANY people give financial advisers a truly criminal amount of money IMHO for "managed funds" - absolute bullshit, 2%? 2.5%? Ugh.

Your money is just that - yours. You need to know what you're buying with the money earned working, working, working. Sure, too much info can lead you up the garden path, but that is a personal issue!

the fixer

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Re: A few misunderstandings about investing
« Reply #11 on: May 09, 2013, 02:21:38 PM »
Something I didn't see anyone mention is what makes stock have any value. Owning a piece of a company has two possible benefits:
  • The company can choose to issue a dividend, a portion of its profits, back to shareholders. The stock price accounts for the projected value of future dividends, kinda like a bond.
  • The company can get sold to another public company, or a private equity firm. The buying company has to compensate all shareholders to give up their stake in the company being sold. The expected amount they would have to pay relates to the company's market cap (share price x #shares).
Another action which I don't think directly gives the stock value is the company can do stock buybacks: repurchase shares so a smaller percentage of the company is publicly owned.