At the beginning of this year, I decided to learn about different investment strategies such as stock market investment and real estate investment. I realized that although, at the moment, I’m quite comfortable at my job, I could lose it in a blink of an eye without warning. And because my job is my only source of income, if I lose my job and unable to find another, I’m at high risk of sinking into debt. Given the COVID-19 pandemic, it’s not out of the question for that situation to arise, and it’s not a great situation to be in.
Since then, I’ve been encouraging my loved ones to look critically at their finances and learn a bit about investment too. Jumping into investing doesn’t happen overnight for many of us, but taking small steps to learn is better than taking no steps at all. However, one of my gripes about learning in other fields is the jargon used to explain concepts.
This article provides a brief and simplistic overview of stock market investment concepts such as bonds, stocks, assets, liabilities, equity, etc. At the end of this article, you should see how all these pieces fit together, and hopefully, this encourages you to do more research!
The Basics
Assets, Liabilities, & Bonds
Assets increase in value or adds value to your future. Most people think assets need to be tangible, but assets can be anything that will increase your wealth in the future; intangible entities. For instance, your education is an asset because it’ll provide you with life-long skills to help turn a profit. Tangible assets, such as a house or shares of a stock, can be exchanged for money immediately.
Liabilities decrease in value over time. Clothes, shoes, and accessories are common investments we make per year. Although it’s necessary to have clothes on your back and shoes on your feet, those clothes and shoes wear and tear after some time. Their value goes down the more we use them, and eventually, they end up recycled.
A person who owns bonds has ownership over liabilities because they’re part-lender to a company. When a company tanks, the owners are obligated to pay back all the lenders of their company. When one owns a bond, they’re issued a bond certificate. The certificate represents the amount of money to be paid back to the lender. The bond certificate is often said to “mature” because some interest will accumulate over time.
Does that sound familiar? It should!
Bonds operate like credit card loans, student loans, car loans etc. Interest accumulates with time, and eventually, the lender earns profit. In some way, liabilities all operate the same; you lose out on a lot more than you expect as a borrower but gain more than you invest as a lender.
Equity & Stocks
Liabilities take away from your assets, and the remaining amount is called equity.
To illustrate, Emily recently bought a new home in a trendy, up and coming neighborhood. Its property value is estimated at $750,000 (Emily’s home is an asset). Emily also has $140,000 in student loans and a total of $40,000 in other loans such as credit cards, line of credit, and loans from friends/family. Her total liability is $180,000. Therefore, if Emily were to sell her home, she would have $570,000 in equity.
A person who owns shares in a company has ownership over equity because they’re part-owner of a company. Shares are a fraction of a company valued at a price. When a company initially goes on the market, also known as an IPO or initial public offering, the quantity of shares up for trading and each share's value is released to the public.
Quick Fact: Companies typically consult an investment bank to crunch some numbers to derive the market value of a share. Once the company is integrated into the stock market, its market value is driven by supply and demand.
The market value or ask price is the value of the share on the market and is what you pay to own a share. The idea behind buying a share isn’t only to look at its market value but to assess the fraction of the company you’ll own at said market value.
Let’s see an example, but using more relatable figures.
Imagine Mcdonald’s has a deal. You could get one junior chicken for $1. But, at Burger King, you could get five chicken sandwiches for $4. You decide you want ten units of whatever choice, so your options are:
- Ten junior chickens for $10
- Ten chicken sandwiches for $8
The best choice is ten chicken sandwiches for $8, because you OWN more, for LESS. Even though Mcdonald’s sandwiches' price seems cheaper, it’s costly to own more in the long run. Stocks work the same way! Don’t be deceived by a stock valued at $4 per share because it might not be a “cheap” stock.
Company Valuation
They’re several ways to evaluate a companies worth. In this section, I’ll be covering some essential terms to help broaden your understanding of how assets, liabilities, and equity play a role in investing.
Market Capitalization
In the previous section, I introduced market value, which is defined as what a company’s share is valued. Market capitalization is the market value multiplied by the number of shares on the market.
Market Capitalization = No. of Shares * Market Value
Market capitalization represents what the market believes is the equity of a company. Remember that equity is calculated as follows:
Equity = Asset — Liability
The market also has beliefs about a company’s assets. If the market believes the company's assets are worth more than what’s reported, then the market value increases. Conversely, if the market believes the company's assets are worth less than what’s reported, then the market value decreases.
So you may be wondering, what influences the markets’ belief?
Remember earlier I pointed out assets can be intangible entities? Intangible entities also influence the market value. For example, a company could have a CEO known for a particular skill that may help increase demand for the companies product. The CEO and their skill are intangible because they offer an asset that can’t be immediately traded but will still profit the company. However, imagine if the CEO left the company, then the market would believe it is worth significantly less because they lost an asset.
Book Value
The book value is the value of a company according to its balance sheets, accounts, and books. The documents that contribute to the book value are updated quarterly or annually. Therefore the book value estimates what a company is worth since figures can change throughout the year.
If the market capitalization is less than the book value, then the market believes the company has fewer assets or is worth less than what’s reported. However, if the market capitalization is greater than the book value, then the market believes the company has more assets or is worth more than what’s reported.
Intrinsic Value
Intrinsic value is a valuation metric that is a little more complicated to explain; it’s very philosophical. The best way I can explain it is:
Intrinsic value is the current price of a share, given its likelihood to turn a profit in the future or given its level of risk.
However, even my definition is not really doing the concept justice. Below is a video of one of the world's most successful investors, Warren Buffet. In the video, Buffet breaks down his philosophy about intrinsic value. It might be a little complicated, but I think this is as beginner-friendly as this concept gets.
Warren Buffet follows Benjamin Graham school of value investing. Value investing is an investment strategy that analyzes undervalued stocks on the market. It uses the intrinsic value as a metric to assess the risk of investing in those stocks.
Getting Started
There’s so much to learn to get started in stock investment, but if you can get over the jargon-barrier, you’re one step closer to buying your first stock, bond, or option (I haven’t covered in this article).
These are a few of the steps I followed before buying my first stock this year. It took a lot of research, and I had a lot of self-doubt. But, consider every step a baby step. Spend as long as you want on each step in this process until you feel comfortable moving to the next.
- Select a company you’re curious about.
- Watch YouTube videos that analyze your favorite companies portfolios. You can get a better sense of a companies book value over the years and compare it to its current market value.
- Research investment strategies. There are plenty of investment strategies and philosophies to choose from. Find one that resonates with you.
- Weigh your brokerage options (I highly suggest Wealthsimple — if you live in Canada, and QuestTrade).
- Seek professional advice. Before signing up with a broker or buying a stock, bond or option, always look for professional advice. Or at least, have someone you can consult with as you’re learning.
I hope you enjoyed this guide, and you continue to look further into stock investment and other forms of investment.
Happy Holidays ❤
