4. What is a Share Video Lecture | Become an Expert: Value Investing - Business Basics

okay welcome to course 1 unit 1 lesson 4
what is a share in this lesson we're
going to learn about five different
lesson objectives
the first lesson objective is what is a
share the second objective is what is
shares outstanding
the third is comparing terminology
between a whole business and ownership
of just one share the fourth is basic
valuation techniques for one share and
the fifth is why is stock investing so
we put it so without further ado let's
get the lesson started ok so we have a
scenario and if you're just joining us
with this lesson there's two other
lessons before this lesson too in lesson
3 where we were talking about an owner
named Nancy who had an ice-cream stand
and we were really trying to understand
how she values that business that small
business and so in this lesson what
we're going to do is something a little
bit different we're still going to use
Nancy in our ice cream stand to teach
concept of breaking a company down into
shares so in the previous lessons we
Nancy was trying to sell her business
for $200,000 so let's say she's having a
hard time selling her business for
$200,000 and now she's wanting to sell
it for $100,000 so that ice-cream stand
that you see right there on the screen
she's trying to sell that business that
small business for $100,000 and she's
really having a lot of problems doing
that and so maybe she's going to break
the company down into shares ok so what
is a share of stock so as you can see I
took the picture of the ice cream stand
which was a whole business which she was
valuing at $100,000 and she was trying
to sell it with no luck and what she did
is she divided this company up into what
we're going to say is 10,000 pieces so
as you see the little squares error
there's this squares represent that she
split that business up into 10,000
different pieces and one piece of that
business which you can see the little
square there equals $10 and the way I
came up with that evaluation there that
market price that that Nancy has is we
simply took the
thousand dollars she she decided to come
to split the business up into ten
thousand shares and therefore if you
take a hundred thousand divided by ten
thousand that's ten dollars per share
the thing to really take away here is
that term shares outstanding is the
correct terminology whenever you'd be
buying stocks when you see that that's
how many pieces the company has been
divided up into so you start with a
whole business and you just look at the
shares outstanding and that's how many
pieces of that business it has been
split up into so if you looked at a
company like Apple they're probably
close to a billion shares outstanding
and so that's how many pieces that that
that Apple is broken up into and if you
own one share well then you own one
billionth of the company so let's
compare the terminology between a whole
business and one share as you learned in
lesson two and three and if you haven't
seen those lessons I would recommend
that you go back and watch those so this
is a little bit more easy for you to
understand but we see the whole business
there in the market price that
terminology market price is what Nancy
is asking for the business she wants
$100,000 for the business as we learned
in lesson two about in the income
statement there's those three documents
there the income statement the balance
sheet in the cash flow statement are the
three documents that a business has that
represents its value and if you can read
those three documents then you can
understand what it's worth so on the
income statement the bottom line on the
income statement that that physical
document is the net income and so we
found out that for Nancy's business her
net income was twenty thousand dollars
and that represents her profit so in one
year she has made twenty thousand
dollars on her business the balance
sheet represents the equity so if Nancy
would end her business if she would kill
her business today
fire her employee and she would sell
everything that she has and pay off over
debts what would be left is seven
thousand dollars and we determined that
that's the equity and we also talked
about how the margin of safety is the
difference between the equity in that
market price so let's say you'd buy this
business for a hundred thousand dollars
and the next day you
have to kill the business because it's
not making any money well the only thing
you'd get out of the business is $7,000
so your margin of safety there is very
little now if the business continues to
run and to be alive you can expect to
make $20,000 in a year so that's the
terminology there and if you want a
further explanation like I said go back
to lesson two and three to really fully
understand that so when we look at the
whole business all those numbers pretty
much make sense and I'm skipping the
cash flow statement cuz that's something
that's taught later on in in course two
now as we look at the one share of the
business which we've determined has been
broken down into 10,000 pieces from that
whole business that you see over there
let's take a look at how that
terminology changes as we look at one
chair okay
so here we are and you can see that we
have one share the total number of
shares outstanding is 10,000 so we know
our market price is $10 a share because
we just took a hundred thousand divided
by 10,000 the best way to really
understand stock investing is to look at
one share like it's a miniature business
like you know this this might sound
crazy but think of maybe like little
miniature people working in that little
miniature ice-cream stand and instead of
it producing a hundred thousand dollars
it's only worth $10 because it's really
small and tiny now that might be a silly
way to look at it but for some people
that really makes things start making
sense for them so let's assume that this
little small business the market price
on it is $10 a share so the earnings for
the business which is the same thing as
net income okay it's the exact same
number but the only difference is net
income is when you're valuing the whole
business and earnings is when you're
only valuing one share it represents the
exact same thing but only for one share
so if you look there if you take the
$20,000 in net income and you divided by
the 10,000 shares outstanding you'd be
left with two dollars the EPS that
earnings we see where it says earnings
in EPS EPS stands for earnings per share
so for one share the earnings is two
dollars
then for the balance sheet we saw over
there on the whole business it was seven
thousand dollars for the equity and so
when you go to a per share basis that
isn't called equity anymore it's called
Book value I don't know why they really
change the terminology as probably so
you know that when a person says well
the book value is two dollars you know
that they're talking per share opposed
to the entire business but what you're
going to find is it doesn't matter if
you're talking the whole business or
you're talking one share it's all
proportional because everything's being
divided every single term is being
divided by the shares outstanding which
is ten thousand so when we look at the
book value for this one share it's 70
cents let's go to the next slide here
and see where this takes us so when
we're trying to get into the valuation
of the business we're going to value
this tiny share this one share the same
exact way that we evaluate all now we
learn different valuation techniques in
lesson two in lesson three and so I'm
going to teach something a little bit
new here price to earnings ratio and
this is everyone's favorite term and
it's all often referred to as the p/e of
the business so when you hear a person
say p/e this is what they're talking
about and all you got to do it's fairly
simple all you got to do is take the
market price which is the P as you can
see here the P divided by the e the
market price divided by the EPS which we
know is the earnings per share okay so
for Nancy's business if we had one share
we know that the market price is ten
dollars and we take that ten dollars
divided by the EPS which is the earnings
and that's the profit that's the
bottom-line profit in one year is two
dollars and you divide those numbers in
which you end up with is a ratio of five
and there's no units on that when you
divide a dollar by a dollar you're gonna
have no units so the ratio is a five and
that would be your PE so what does that
mean that five that we came up with so
what so your PE is a five but what does
that mean why is that number important
so the best way I can describe the PE
ratio is to remember this phrase if you
read this phrase for every then
the star represents the the p/e ratio
you'll put that p/e ratio in where the
star is okay so for every five dollars I
spend buying this stock I should receive
$1.00 in profit a year later so that's a
really powerful sentence to remember if
that's something you you're taking notes
I would definitely write that down
because that sentence applies for any
company if you're talking about
something on the New York Stock Exchange
right now you can apply that sentence to
the p/e ratio so let's say that the p/e
ratio is 10 for a company so you'd say
for every ten dollars I spent buying
this stock I should receive $1.00 in
profit a year later so as you can see
the higher that the p/e ratio is the
worse that sentence sounds because if I
said for every hundred dollars I spent
buying the stock I should receive $1
profit a year later
that doesn't sound nearly as good as for
every five dollars I spent buying the
stock I should receive $1.00 in profit
year later so when you start talking p/e
ratios you're obviously looking for
something that's lower because that's a
lot better than something that's higher
and all you're doing to figure that out
is you're taking the current market
price of what the company is trading for
and you just divide it by the EPS okay
so when we look at the whole business
versus one share I want to show you how
it doesn't matter if you're valuing the
entire business or you're just valuing
one share when we look at the whole
business we know that the net income or
the profit is $20,000 for the year and
that the market price is $100,000 so if
you had $100,000 to buy Nancy's business
and you bought it and one year later you
could expect to earn $20,000 on your net
income so your return your expected
return in one year would be 20% because
20 divided by a hundred is 20% now let's
look at the numbers for the one share so
when we're looking at that little micro
business is how I I want you guys to
look at it you'd see that the earnings
and all I did was I took those numbers
and I divided it by 10,000 because that
was the number of shares outstanding so
that will represent the value of one
share
you can see that the earnings is $2 and
that the market price is $10 so my
expected return in one year is the same
thing it's 20% so the point that I want
you to take away from this slide is that
regardless a lot of people think that if
they're buying one share that's
different than if they were going to buy
the entire business and that is just
absolutely false every time you look at
just one share you need to look at it as
if you were valuing the entire business
like you're gonna buy the entire thing
so if we're talking about Apple if you
buy one share of Apple you might as well
be buying the entire thing because all
the numbers are proportional so that's
something that you absolutely have to
understand and whenever I see people
trading stock you know these day traders
and things like that it's it's kind of
frustrating because they really don't
understand what's actually happening
here and that they're they're buying a
business there absolutely positively
buying a business every time they buy
one share and that's something that is
so fundamental to value investing and
what this site really represents it
buffets books so why is stock investing
so lucrative okay so the best way I can
I can explain this to people is kind of
give them an example so we were just
talking about Nancy's ice cream stand so
as you look at that ice cream stand and
I asked you would you buy this business
for a million dollars how would you
answer that question most likely you're
going to laugh and be like absolutely
not that's that's just crazy talk so
after we establish that let's look at
something else okay
would you buy this business for two
trillion dollars this is this business
represents GE okay and that's everything
if you could buy the entire business of
General Electric which is an enormous
company all throughout the country
they're all over the world
everyone's heard of General Electric and
they probably have a washer and dryer
that's done in their basement from
General Electric but would you buy that
entire business for two trillion dollars
now for a lot of people that's going to
be a lot harder question to answer
because you know if it was 2 billion to
2 trillion those numbers just really
don't make sense to most people that
it's it's like asking a
an year-old whether they know how much
ten million dollars is and they have no
clue they doesn't even make sense to
them because that's not something that
they're familiar with okay so my point
in showing you they're asking you those
those two questions what I did is I use
the proportion and when I asked you if
you'd be willing to pay a million
dollars for Nancy's ice-cream stand
basically what I did is I took ten times
the current market price which is
somewhat of a believable price and I
took ten times that to ask you a million
dollars and I did the exact same thing
with General Electric right now the the
current market price for if you want to
buy every single share of General
Electric would be about two hundred and
four billion dollars so the ten times
that would be around two trillion
dollars so the question that I initially
asked you at the ice cream stand was
totally ridiculous and the question that
I asked you about the General Electric
was equally ridiculous because it was
the same amount over the actual price
and so I bring this up to highlight the
difference that most people have once
you start getting past the million
dollar or the ten million dollar mark
most people have no clue what the value
of something is they just it doesn't
even make sense to them and so it
further gets complicated when you take a
large business like this and then you
chop it up into millions and billions of
shares and you're saying all the
companies 20 dollars a share that means
nothing to people they just they just
don't understand it and so if you value
one share of the business like you're
going to value the whole business you're
going to find that you're going to have
much more success when you get involved
in the stock market so the thing that I
really want you to understand here this
is if you look at the ice cream stand
this if a person was going to buy that
ice cream stand they're going to do the
numbers they're going to do the hard
math and they're typically going to
they're going to purchase something like
that based off of numbers but what you
find in the stock market is you have a
lot of people who don't know what
they're doing other art let me clarify
there's a lot of people who do know what
they're doing in the stock market but
there's a lot of people who don't and
what they do is
they trade on a motion opposed to the
numbers because they they never fully
understand what's actually happening
with the numbers and they have no idea
what the value of a company that size
actually is so the thing that to really
understand here the reason that stocks
are so lucrative is because there's a
lot of people that are trading on
emotion they're saying oh well you know
I have a I have a General Electric
washer down in my in my basement and
it's it's really good I really like it
so I'm going to buy shares of that
company and that's their investment
approach which is you know unfortunately
it's kind of scary that people think
like that and they think that they can
be successful and they might be paying
10 times the value of the company and
they have no idea they have absolutely
no idea so the answer the question the
reason that it's so lucrative is because
there's so many traders out there that
are moving these market prices not day
to day but through the years what you'll
see is that some of these prices
sometimes are offered to you to buy a
company like General Electric at a
really cheap price you go back in the
2008-2009 some of the prices that you
could buy companies for that literally
had no debt we're totally insane it
didn't even make sense how people could
be trading them as low as they were and
now as we're looking at 2012 when I'm
recording this video things are getting
a little bit more expensive and prices
are raising so you're not going to be
able to get as good of a deal on some of
the companies so your job is to always
calculate the intrinsic value of the
business regardless of how big it is and
then compare that value to the price
that it's trading for and hopefully
you'll get a good deal so that pretty
much summarizes the lesson objectives
that we want to accomplish through this
lesson and I just want to highlight that
at the bottom of the lesson for webpage
I have a practical exercise where I take
people through a real company on the
internet and show them all the
terminology that we've been learning
through the last four lessons so if you
want to know where you can find the book
value number or you want to find where
you can see what the earnings per share
the EPS is at just click on the link
below on this lessons page and I have a
practical exercise and I'm going to take
you through and kind
show you where all these numbers are at
so it starts makes making sense for you
so the things that we learned in this
lesson we first figured out what is a
share then we learned what the term
shares outstanding is then we compared
the terminology between a whole business
and one share we learn the basic
valuation techniques for one share with
the price to earnings ratio and then we
learned why stock investing is so
lucrative so that concludes this lesson
and be sure to check out the practical
exercise if you want to see where some
of the terminology is and we'll see in
the next lesson