What Are Stocks?
When I was 17 years old, I took a trip to Houston, Texas to visit my uncle and his family. He was a financial advisor at the time, so it sure seemed like he knew a lot about money. This was in the summer of 2005 when the price of something called “light sweet crude” was approaching $60 dollars a barrel on the futures market for the first time ever. There are a lot of big words in that last sentence that I wasn’t really familiar with at the time, and honestly I still don’t know much about the difference between “light sweet crude” and “brent crude,” but the gist of the sentence was that oil had been more expensive at that point than it had ever been before.
One day, while I was playing H-O-R-S-E with my little cousin Larry, my uncle bought shares of an oil company for his son’s portfolio. We had a day trip out to Galveston where you can see oil rigs out on the horizon, and when my uncle explained to Larry that he was the proud owner of some of those oil rigs, the look on his face was as if someone had just told him he owned the moon. Larry’s reaction is completely defensible because at the time he was a six-year-old.
Not too long ago, I was at a friend’s birthday party. It was at this cute little dive bar called “Montana” that’s really in Seattle, and there was one tiny TV showing Game Four of the NBA Finals. Our table was covered in drink cups, and everyone was having a good time when the birthday girl mentioned that she was just thankful she didn’t have any Facebook stock, joking about the poor early returns of the IPO.
The discussion quickly devolved from there when someone made what I thought at the time was a very bad joke by asking, “What is stock, really? What are you buying when you buy stock? I want to sell stock to you.”
And someone played along, “Stock in what?”
“Not stock in anything, just pure stock.” If I had been a little more drunk at the time, and if I had been a little less invested in the outcome of the basketball game now in its second quarter, I could have very easily found myself taking him seriously and yelling, outraged, about this obvious ponzi scheme. Thankfully for everyone at the table (except for the OKC Thunder fan in the corner), I was more interested in Lebron James’s post-up game, and how it would help ensure that at least this year, Clay Bennett wouldn’t be getting a championship ring.
Fast forward to Thursday. The birthday girl has recovered from her birthday hangover, and we’re making plans to go watch Game Five of the NBA Finals at another bar (Kate’s Pub in Wallingford, where, from 4 p.m. to 7 p.m. every day, all food on the menu is 50 percent off with your drink order), and I had to ask her: “Your friend, the one with the curly hair talking about ‘pure stock,’ is he mentally deficient? Does he really not know what stocks are?” Her answer shouldn’t have surprised me, but it did a little bit.
“No, he’s actually really smart.” That’s not the part that surprised me. “I’m not sure I really understand stocks.” That’s what surprised me.
When I say that it shouldn’t surprise me, I’m not implying that I think very little of my friend. On the contrary, I think a great deal of her—otherwise we wouldn’t be friends. I say that it shouldn’t surprise me because I’ve grown up my entire life with people who aren’t really given any financial education.
I didn’t see the look on her face when she told me that, because the discussion was done over Gchat, but she did give me one of the little :-/ emoticons. If I take that emoticon to say, “I don’t know how to feel about that, but at least I’m not :-(, or :’(,” then I think that reaction is just as defensible as Larry’s jubilation.
The idea of stock should be simple really, but it’s scary, because on MSNBC, there’s this rolling ticker with hundreds of stocks on it, and they show all these graphs and talk about opening and closing prices. It’s hard to imagine that Facebook—something that I use every day to look at pictures of my friend and other people I don’t know yet—can be worth some amount one day, and then the next day, it’s worth some wildly different amount. I don’t really understand why people think Facebook should be worth $60 billion, or $30 billion, or $100 billion dollars. That’s too many dollars for someone like me, without a fancy job, to think about.
What I do understand is the idea of ownership. My friend Danny owns an ice cream selling business. It’s called “Danny’s Summer Relief.” It’s a really simple business, and the work is mostly seasonal, but in the purest sense of the phrase, my friend Danny is a job creator, and all it took was an ice cream cart that cost a couple hundred dollars. Now, all he does is buy ice cream at Costco, marks it up for resale, and hopes for good weather. The difference between what he pays for the ice cream and what he sells it for is his profit, which sometimes he considers reinvesting in his business.
For example, I read an article on the Billfold about artisanal ice cream, which made me think to send a message to Danny and tell him he should consider making his own popsicles and selling them rather than just buying them from Costco. Let’s say for argument’s sake that Danny didn’t have enough money to buy all the things he needed to make his own ice cream at home, but that he really wanted to have this stuff. Danny needs an investor who can offer him enough money to buy the stuff he needs, so he could offer to sell part of his company to me. That sounds fair.
Now, for arguments sake, I own part of his company, and I’m entitled to a portion of the company’s profits. That’s basically what stock is: little tiny shares of a company, and it only seems like magic. The way Danny’s business and Facebook will distribute profits to their owners will differ a little bit. Since Danny’s Summer Relief is likely a sole proprietorship or an LLC the profits can be paid directly to the owners. A corporation like Facebook will have to pay out dividends to its shareholders. These different kinds of payments are taxed differently but they each make the motivations of be business owners clear: They want more money.
Facebook is similar to my friend Danny’s business in some very basic ways. Mark Zuckerberg sat in his dorm room at Harvard and created it. Then somehow it was marketed to college students, then the friends of college students, and eventually (sadly, to some) to the parents of college students. Now, Facebook makes a lot of money by selling information and ad space (even though ads aren’t cool), and the people who have shares in Facebook are entitled to the profits from the sale of information.*
The difference between Danny’s Summer Relief and Facebook, one of the many differences, is that it’s very easy to place a value on Danny’s Summer Relief, because it has one asset, a cart, a very small inventory of ice cream bars, sales that are pretty predictable, and one single solitary employee (my friend Danny is a job creator, singular). Facebook on the other hand has hundreds of thousands of assets, tons of employees, and a product which even the people who are familiar with disagree on the value of.
The truth is, no one in the world knows for certain how much Facebook is worth, which is to say, no one really knows how much profits Facebook can make in the future. For the past month, people have suggested that Facebook is worth somewhere between $30 billion and $100 billion dollars. Right now, the best guess is $71 billion dollars, or 33.41 per share. Tomorrow, there’s a good chance that people will agree that number isn’t right.
*Side note: One of the people who has shares of Facebook is Chris Hansen, who is using some of his money to try to start a new business, one of whose assets I hope will be a professional basketball team so that I can stop rooting for the Heat and go back to rooting for the Sonics, but still rooting for any team playing against the Thunder, except for the Spurs.