Explaining the Stock market to a 12 Year Old
Explaining the Stock market to a 12 Year Old
I was reading the newspaper the other day, particularly the stock market section, when the 12 year old son of a friend asked me what the table of numbers on the page was. I said that it’s the stock market prices of Philippine companies.
He obviously got curious because he then asked me to explain what the stock market is and why it’s so important that newspapers publish that table every day.
The 12 year old kid got curious on the stock market
He’s a smart kid and I know he’d appreciate if I explained the stock market further to him, but I had to make it simple as I could. So here’s how it went:
“You know my internet cafe, right?” I began.
“Yeah, that’s your business,” he replied.
“Who owns it?” I asked
“Yes, me and a bunch of other people. We’re a company – a private corporation,” I answered. “It’s a corporation because the owners of the business is limited to only a small group of people.”
“Now, some business, very big business like Jollibee – they’re public companies,” I continued. “That means it is owned by a whole lot of people.”
“How come there are private companies and public companies?” He inquired.
“All businesses usually start out as private company. Then after a few years, they might want to grow and expand – like put more branches or develop more products. And sometimes, the best way to do that is to sell a part of the company to other people,” I explained.
“So let’s say I want to put a new branch of my internet café but I don’t have enough money to do so,” I said. “Then I can perhaps ask your father to invest in the business.”
“Invest?” he was a bit confused.
“Yes, that means I will ask your father to buy a part of the business. And when he does and I receive his money, I can then use that to put up a new branch. But this time, when the business earns money, we the original owners of the company, would no longer get all the profit because we have to give your father his share of the income.”
“Because he is already one of the owners of the company,” He says.
“That’s right,” I concurred. “Now what if our plan is to put up hundreds of branches all over the country – your father’s money will not be enough to do that. We need more people to invest in the business. And one of the ways to do that is to make our private company, public. Which means we will be selling part ownership of our business to the public and anyone who wants to become an owner can buy a share.”
“So when that happens,“ he concludes. “Your private company now becomes a public company.”
“Yes, that’s right.” I agreed “And that’s where the stock market comes in. The stock market is a place where you can buy shares of public companies and become a part owner of those businesses.’
“And make money when the businesses earns, right? He quipped.
STOCK MARKET TICKER
“Yeah, you can say that. But not all companies give dividends. That’s what you call the income you get as an owner of the public company.” I replied.
“So why would you buy a share of a company if they won’t give you a portion of their profit?” he inquired.
“That’s a very good question!” I exclaimed.
“So why would you buy a share of a company that doesn’t give dividends?” I repeated.
“Because they can just suddenly decide to do so.”
“It’s a bit complicated but there is always a possibility that a business can give out dividends in the future and that’s always something that people hope for.”
“But more importantly,” I continued. “One more reason why you’d want to buy a share of a company, even if they don’t give out regular dividends is because there are other ways to make money from it.”
“Really?” the boy was more curious now than before.
“Yes you can make money from selling your share of the company to others.” I replied. “But first, let me now explain to you what all these nubbers in the newspaper are.”
“This table is a list of the public companies in the Philippines and how much a share of that company is worth,” I continued. “For example, if you look at this, you’ll see that a share in Jollibee (JFC) is currently worth around P53.00. Which means if you want to become a part owner of Jollibee, then you’d have to spend P53 for every share you want.”
“So with just P53.00 I can become an owner of Jollibee?” he was obviously delighted with that realization.
“Theoretically, yes. But the stock market has rules, depending on the price – there is a minimum shares you need to buy. For this price it’s 10 shares. So that means you’d need to spend around P530.00 to become a part owner of Jollibee,” I explained.
“Can you still follow me?”
“Now, let’s say I bought 100 shares of Jollibee today at P5,300.00 per share. Then after a few months, the company announces that they’re planning to put up more branches in other countries.”
“That will be a great new for me and all those who are shareholders of the company.” I explained. Because it means that when it accomplishes that goal, Jollibee will be earning more money than eve before – which means the dividends that I might get as part owner will be potentially higher.”
“Knowing that news, wouldn’t you want also buy shares of Jollibee? I asked.
“So you can also get dividends in the future and not just me?”
“Yes,of course,” He answered.
“so now, I’m in very good position to earn. Because you and a lot of other people would want to buy shares of Jollibee, I can just decide to just sell my shares. In doing so, I will forego receiving possible dividends in the future, but in exchange, I’ll be able to make some money now.” I explained. “Are you willing to buy y 100 shares for P5, 500.00 each?
“Oh I get it now. You can decide to sell your shares at a higher price than how much you bought it. But what if I want to buy them at the sme price as you did, P53.00” he said.
“You can, but you’d have to find someone who is willing to sell at that price.” I answered. “And in my case, I would have to find someone who will be willing to buy them at P55.00 per share.”
“So how would we do that?” he asked.
“Well, you have to go to the stock market and sort of announce it there. For me, I would also do the same thing. And the people in the stock market will automatically match the buyers and the sellers and transactions for us,” I answered.
“And that’s why the newspaper publishes this table everyday.” I continued. “Because people buy and sell these numbers tell how much the price of each share were brought and sold. It also shares how many shares exchanged ownership, that’s what the number under the Volume column means. Tis table also has a lot of other information of what happened today n the stock market.”
“Okay.” He replied intently.
The prices change everyday. Sometimes it goes up, sometimes it goes down – there are many factors affect it but at the most basic level –I’t dictated by how people feel about the particular company. When people believe that the company will do good, many will buy shares and the price can go up. But if they feel that the business will do bad, more people will sell their shares nd that’s how the price would go down.”
“I see,” he said in a quiet manner. He was obviously getting information overload. Moreover, I already saw that my friend was about ready to go and we’d have to leave their house soon. And so I tried ot end the conversation with an advice.
“You know, you’re quite lucky. I was able to understand the basics of the stock market when I was in college but you , you already know it and you’re just in high school.”
“Reallly? His enthusiastic voice was back.
“Yeah the stock market is really an interesting place. And if you take some time to learn more about it, you’ll realize that it’s a good way to make money.”
And with that note, our conversation ended.
Interestingly, as I told my friend about what me and his son talked about, he also became interested and asked me if I can help him learn more about the stock market.
READY TO BE RICH
This is an an excerpt from the book: The Ready To Be Rich: Guide To Investing by Fitz Villafuerte
Fitz Villafuerte is a Filipino entrepreneur, an investor and a Registered Financial Planner. He is one of the best business and finance blogger best known for his authority blog entitled Ready To Be Rich @ www.fitzvillafuerte.com.
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