How does stock price correlate with a company's income?

[jab105]

Stock price is not directly related to the income of a company is it? A freeper friend is trying to tell me that if he invests in a stock, that the money goes to the workers in the factory...but I'm pretty sure this isnt accurate, it doesn't stay in circulation in the economy, does it? Please help!!

(sorry in advance for such a silly question)

[wtmusic]

1. Price can be related to income

When you invest in stock you are actually buying a piece (or share) of the company. The price of it depends on a lot of factors, including the earnings the company is producing, future prospects, competition, even politics!

[jab105]

2. But where does my money go....

if I was to buy a share of a stock for $100...where specifically does my $100 go?

It doesn't go to pay Joe Schmo worker in the factory...but where does it go?

[wtmusic]

3. Whoever sold it to you

Stock is traded just like people trade baseball cards, Barbie dolls, whatever.

If you want to buy stock you call a broker, he finds somebody who wants to sell it, then he takes a commission for hooking the sale up (it's a little more complicated than that)

[mastein]

4. What stocks are

Stock is issued initially by the management of a company. They sell a piece (or percentage) of that company in order to raise money (capital) to buy both goods and services (including the aforementioned employee time) to grow the company. Once that stock has been issued it has a life of its own. It can be bought and sold as buyers and sellers see fit. To see just how much the price of a stock is tied to the amount of money a company makes you can look at the column in the newspaper report marked "P/E" which stands for Price per dollar of earnings.

When one buys stock you are buying potential profit and that price is usually several times the amount made per share that year.

Brokers who handle the nuts and bolts and hook up the sales do get a piece of the action when sales are made.

Hope this helps.

[TrogL]

5. These days

The price of a stock has apparently absolutely nothing to do with anything. Stock prices go up and down based upon increasingly intangible whims that appear to have little or nothing to do with the actual value of the company.

[mastein]

6. Agreed,

but I thought the econ 101 lesson might be in order. It also highlights the notion of caviat emptor or buyer beware. Stocks that are overvalued, that is, cost too much are not ones you want to own. One of the things the SEC/NYSE is next to investigate is manipulation of prices by companies who frequently trade in the stock. . .

http://money.cnn.com/2003/09/23/markets/nyse_plan.dj/index.htm

Cheers,

[Don Galt]

14. Stock prices are a multiple of earnings, that's all.

Over the short term, stock prices will fluctuate based on what people think earnings will do in the short term... but restricted to a range of reasonable scenarios.

Over the long term, stock prices follow the earnings of the company- ALWAYS.

If you have a good company that earns %30 more every year than it did the previous year, the stock price will usually be 30 times the previous years earnings per share.

Say Microsoft earns $5 a share and is growing steadily at %30, its price will be $150 a share.

If people think this is likely to change, the price will be fluctuating around $140-$160 a share.

If coca-cola is earning $1 a share and has been growing their income at %12 a year for the last 10 year,s then people will usually pay around $12 a share for coca-cola stock.

Sometimes prices get out of whack with earnings-- this can happen when it is unclear how fast a company will grow. This is what caused the recent stock market run up and then run down.

But even as stocks have been "Crashing" many stocks have grown-- you just don't hear about them because they aren't dramatic enough to make the evening news.

There's a great book called Buffettology that explains Warren Buffetts stock picking strategy... if you follow it prudently, you're going to make a consistent %10-%20 on your money every year, over the long term.

Contrary to popular belief, the stock market is not a casino. People do gamble there, but they are gamblers. Investors do not gamble. Over all, investors make money. On the other hand, every gambler, over all, ,looses money because the odds are stacked against him.

Nowdays, reasonable investment, the odds are stacked in your favor on the stock market. But you can't just pick companies willy nilly-- if the company is selling for 40 times its earnings and its only growing at %10 a year, you can expect your investment to loose a lot of value over the long run!

Read up on it... any of the fool.com books, or warren buffet books would be good reading for someone new to investing.

[Don Galt]

15. Yes it creates jobs, pays wages.

If you bought the stock from the company, in a direct purchas program, or during an initial or secondary offering ,the money goes directly into the companies expenses-- for instance, paying factory workers, or building a new factory (the common use of offering proceeds) to hire new workers and grow the business. Most workers salaries are paid out of operating cash flow... which is bigger than income from stock sales in healthy companies-- the stock sales being a relatively rare event when the company wants to significantly expand.

If you buy the stock on the open market, your money does go to the person who sold it, but this also helps the market keep open for the company to use to borrow against.

Stock is really a form of borrowing for companies-- tehy raise capital that is used to build plants and create jobs, but they shares can be traded amongst people afterwards. Eventually the company will probably buy back shares when it has reached saturation and can't grow much more... which is a return of the money that was "lent" to them when the shares were originally sold to investors.

Money you put into the stock market does directly or indirectly help create jobs.

Plus it will help you retire.

[lancemurdoch]

7. stock price

Over the long-term, stock price usually follows earnings, with the p/e ratio reflecting what people think of future earnings growth potential.

If you invest in a public offering, you are providing cash (capital) to the company in exchange for part ownership of the company. After the public offering, you're just buying the share off them, and the company is not part of it - it's like buying a new car from a Ford dealer, then re-selling it - Ford is no longer involved at that point in the transaction.

If you look at most public offerings, they detail what capital they will buy with the money, and then hire workers to work on it, the wealth the workers create paying their own incomes, with the value they create in their surplus labor time expropriated as profits.

[rapier]

8. notes

Where to begin?

You are asking two questions, or is it three.

Stock prices are related to company income only in that some people buy stock on reported income. A company doing well cash flow wise might see its stock rise. That however doesn't seem to really be the question you want answered.

What the freeper seems to be saying is that the money from stock sales go to the company. This is very simple. The money from stock sales go to the seller. Only once does a company sell it's stock, and that is when it is issued. It does take that money. After that the stock has NOTHING directly to do with the companies balance sheet. (indirectly a strong stock price can make it cheaper for the company to borrow money and to do deals. These are indirect benefits) Your freeper is a nut job. A fool.

The proceeds from stock sales stay in the economy of course. The seller can with the proceeds buy a new car, a hooker or more stock. What the money doesn't do is help the comapany. They are not a party to the transaction.

A stock is actually a drain on a company. If they pay a dividend that is money that comes out of the company to the holder. Stocks are a CLAIIM against a company.

None of the great corporations (great as in large and successfull) ever needed the money from their initial stock sales to grow. Sucessfull companies have ALWAYS grown on their positive cash flow. GM, GE, DuPont, Microsoft, and on and on and on didn't need the money from their initial stock sales. (comapanies often issue more stock later to raise money because they need it but the basic point is still valid. Successful startups don't need the money from stock sales)

So why do companies sell stock and go public? Because the legal and tax advantages are so gigantic that it's worth it. That is why corporations now dominate our economy and culture. It has nothing to do with individualism. Corporations are anti individual. As all know, groups are more powerful than individuals. Add to that the mentioned tax and legal advantages and presto, we have corporatism. Individuals at the pinacle of heirarchys, corporations, reap the most.

[Don Galt]

16. This is simply false.

ALL the large, successful companies have needed the money from their offerings to grow. After all, these are well managed companies-- if htey could grow just from cash flow at the same rate, they would never sell part of the company! The reality is they grow much faster with the IPO than just organically from free cash flow... they do spend most of their time growing from free cash flow, but they are not wasting their reciepts from stock sales.

Microsoft damn well needed the money from its IPO to grow! They were a small company when they IPOd. Same thing with Intel, GM, Dupont, GE, etc. All these companies have used their proceeds to create jobs.

In fact, all public companies use their IPO and secondary offering money to build plants, factories, new lines of business, etc. All money invested in stock offerings, ultimately, goes to creat jobs and pay wages at those companies.

They have to, or the wouldnt' be able to sell big chunks of stock like that.

When they are going to do an offering, they have to do a road show to the invetment banks who tend to buy the big lots of stock they have to sell (Because the volume is too large for the market to handle all at once)... and they have to pitch these people on teh investmetn, and how they will use the investment to grow the company-- which will result in a higher stock price when the bank chooses to sell the stock.

Stock price is not TIED to earnings, it is a market price-- but it is so heavily influenced by earnings that over the long haul, stock prices will follow earnings. Of the short term they fluctuate... but to imply there is no relation is incorrect.

The idea that the CEO is taking IPO money home is silly... that would be fraudulent and wouldn't be tolerated by he people who facillitate the offering. In fact, most CEOs who are "lavishly paid" are actually not taking home the money they could-- they leave it in the company for 20 or 30 years and then when they retire, they take all that invested stock and sell it. Causing a newspaper to say they recieved $140 million in one year (a lie, like they told about the NYSE CEO)... when in reality they earned that money over decades-- but left it in the stock of the company-- before taking it home.

[rapier]

17. notes

Microsoft was always rich in cash. I'll just add that I guess I missed the biggest reason companys go public. The owners do it to capitalize their assets. Microsoft was always rich in cash. If Microsoft never went pubic Gates might have decided to skim off a big part of the multi billion dollar cash reserve they've had for years but that pales in comparison with his stock holdings. What's that worth now? $400 billion or so. Which he sells off bit by bit, billions at a time.

GM, DuPont and the rest could easily have funded their capital needs with cash flow and borrowing. But their owners would not be nearly as rich. That is asset rich by the way. Not income rich.

It should be noted that the bond offerings of public companies are far far easier to market. Again, capital is far easier to raise for a public company. Yes, borrowed money is capital. Being a publicly traded company puts you on the map on Wall St. They will work for you. Tout your stocks and sell your bonds.

There are thousands of people who are worth in the eight figures from the dotcom era whose companies never made a dime and never had a chance in hell of ever making one. They KNEW how to capitalize themselves, thru stocks. That's what it's always about.

Anecdote.

Nearby here in Grand Rapids Michigan one of the largest privately held corporations in America went public in the late 90s, Steelcase. A near hundred year old privately held company. A couple of families owned the huge bulk of the stock. While I suppose that stock was always for sale as a practical matter it just wasn't very wise to sell it. Besides, how do you price it?

So while they held this stock it was static. They could look at their balance sheets at the end of the year and say I'm worth X billion, but they couldn't spend it. They could only spend what they took as a dividend.

Then, in a move of brilliant timeing they announced the decision to go public, at the height of the bull. Now I don't know the exact number of shares or the initial price but at the end of the day they sold the pevious owners had probably in excess of $20 billion or more in the bank. Their asset had been capitalized, in full, plus some. (in that the company has fallen on hard times)

That scourage of conservatives, Warren Buffet, holds billions worth of his companies stock. Is he a billionare? No. Why? Because he has said he will NEVER sell his stock. Most probably won't get the point of that but it means everything.

[mhr]

9. Hi Jab105

Put simply the first time the stock is sold by the company the money goes to the company.

Thereafter, each time the stock is sold the money is merely traded between the buyer and seller.

So your friend is correct, to some degree, on new issue stock, but incorrect for existing stock traded on the stock exchanges.

[German-Lefty]

10. Investing does give investors money and can indirrectly help a company.

Think of Johny millionare, investing in one startup or private corporation after another. Only about 10% of these ever make it big and IPO. If Johny's smart he'll make sure to keep a good eye on these little companies, and vote inteligently with his shares.

So buying stock from Johny on the stock market dirrectly or indirrectly gives him cash to start on his next big project. At least, if he can think of something that's going to be worth investing in, otherwise he may just run off with the doe. But hey, you are paying Johny for shares in something that is going to make you money, or at least you should be.

So retroactively investing in a company may help that company very little, but it may help others, through displacement.

--- Flip Side
Of course if Johny is trying to pawn off some crap like pets.com on you, screw Johny and his bubble making friends. He doesn't diserve any money for just blindly investing in crap. The market says so (and they market is always right, right?).

There is also nothing stopping Johny from taking the money and investing it in China. You may have to saturate the Chinese investment market before your money generates more jobs in the US.

--- Final note
If you did want your money to improve the lot of some company, buy thier bonds. If you decrease thier intrest rates that'll make them more able to invest.

If you want to create jobs in your community invest there.

But what ever you do, do it wisely don't blow your money all on one thing. Don't risk money you can't afford to loose. Invest wisely. You're not smarter than everyone else (or probably not). Don't expect to make too much more than the average interest rate. Don't let human emotions get the better of you.

[TrogL]

11. So what about the case of companies buying back their own stock

When does this help?

[rapier]

13. notes

This helps the stock price, or is meant to. The calculation goes like this.

Company X has one million shares priced at $10. That adds up to $10 million and that number is called a companies capitalization and and the logic, flawed as it is, says this is what the market thinks a company is worth.. If they buy back 100,000 shares the same logic says that if the company is worth $10 million than with only 900,000 shares outstanding then each should be worth $11.11.

In cruder terms all that buying creates demand in the stock and that should make the price go up.

Stock buybacks are especilly popular because it's popular. OK that doesn't make sense I know but stock buyers like it when companies do it so they do it. Announcing a buyback was highly likely to make the price go up short term as 'investors' bought on the news. (suckers)

THe real benefit goes to the executives who have lot of stock options. Anything that makes the stock go up is good for them.

One other point. While stock buybacks were epideminc during the boom a little known fact is that many companies gave away as many new shares to the executives for their option grants as they retired by buying on the open market. In other words they were not really reducing the number of their shares. The stock would often rise on the announcement of the buyback then thru the backdoor they would issue new shares to the execs. What a scam. Even worse, and I know some might find this hard to believe, but sometimes companies would not actually buy back the shares they claimed they were going to.

All part of the greatest wealth transfer in world history, still ongoing. Unless one understands that stocks are the arena of the worlds biggest theives grifters and shills one is defenseless and deserves to lose everything.

[rapier]

12. .00000000000001%

of all stock transactions are new stocks issued by a company, whose proceeds they can then use. In other words the purchase of said shares can be called investment in the traditional sense. (OK, that number is a guess. It might be worse. At the height of the stock mania there were $5 in stock transactions for every $1 in real economic activity. It's down to 3/1 now I think. I can't name the billions per day in stock trading but it DWARFS new stock offerings)