How The Stock Market Works

January 1, 2018

If you're new to investing, the stock market can seem really complex and be very intimidating.  Fortunately, it only takes a little bit of learning to turn this crazy place called the stock market into a simple idea that you can participate in, enjoy and profit from.

How stocks work

If you really want to know the full story of how stocks work, this cartoon -- yes, cartoon -- does a really good job of explaining everything from how a company raises money by selling shares of stock all the way through to how investors can buy and sell that stock on exchanges.  Some of it is a little outdated from a technology perspective (basically replace all in-person interactions with computerized versions that take milliseconds).... but the basic idea is there.

How investing works

When you invest in a company, you can do so through the purchase of "shares" of stock.  Each share of stock represents your actual ownership in the company.  Some companies issue billions of shares of stock, and some issue far less, so a "share" is not the same percentage of company A as it is company B.  

When you buy shares of stock, you're buying ownership in the company.  This means that when the company pays a dividend (portion of profits) to its owners, you'll get in on the action.  It also means that as the value of the company increases or decreases, so too will the value of the share of stock you hold.  There are a lot of things that can go into determining the value of the company (profitability, growth, assets, belief in the business model, etc).... but ultimately the value is set buy buyers and sellers coming together on a price that they will trade the stock at, as seen in the video above.

Bottom line -- you want to own shares in companies that do very well and increase in value, and you want to avoid owning shares in companies that do poorly.  We'll get into some ways of telling the difference in a subsequent lesson.

Example:  Weight Watchers

Weight Watchers is a public company, meaning that its shares trade on an exchange, and you can buy them through a brokerage account (more on that later).

Here's a really quick look at how the company turned around from a struggling has-been, and into a dominating force.

Weight Watchers stock gained value as the company started to perform well with consumers.

In the summer of 2017, Weight Watchers stock was around $27 per share.  That means if you wanted to buy 100 shares, it would have cost you $2700.

About that same time, we noticed through our analysis of social media data that more and more people were talking about joining Weight Watchers than ever before.  In other words, the company was doing well.

A few months later, the company announced that its profits were growing on stronger sales, and the stock moved higher as a result (more people wanted to own the company!)... moving up to $42/share.  That would make your 100 shares now worth $4200.

But Weight Watchers didn't stop there.  The company has continued to add new subscribers at a high rate, which has increased the value of the company substantially.  In fact, at one point those 100 shares would have been worth over $10,000 -- just a year after being purchased for $2700.

Of course, the opposite can happen as well... stocks can lose value (and there are ways to profit off of that as well, but that's a different lesson).

That's enough for now.  Hopefully you better understand how the stock market works, and how investing works.  Our next lesson will get a little more specific -- diving into what makes a good company to invest in and how you can identify the next profitable investment.

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